ORDER

N.V. Vasudevan, Vice-President - This is an appeal by the Assessee against the order dated 24.8.2017 of CIT (A)-3, Bengaluru, relating to AY 2012-13.

2. The Assessee is a company engaged in the business of providing contract Software Development Services (SWD Services) to its holding company Huawei Tech Investment company Ltd., Hong Kong which in turn is a subsidiary of Huawei China. The transaction of rendering software development services to holding company was a transaction with an Associated Enterprise (AE) and was therefore an international transaction. As per the provisions of Sec.92 of the Act, income from international transaction has to be computed having regard to Arm's Length Price (ALP).

3. It is not in dispute between the Assessee and the revenue that the Transaction Net Margin Method (TNMM) was the Most Appropriate Method (MAM) for determination of ALP and that the profit level indicator to be adopted for comparison of the Assessee's profit with that of comparable companies was Operating Profit/Total Cost (OP/TC). The OP/TC of the Assessee was 7.71%. The Assessee in it's TP study selected 14 comparable companies whose arithmetic mean of OP/TC was arrived at 13.21%. Since the profit margin of the Assessee was within the -5% profit margin of the arithmetic mean of OP/TC of the 14 comparables selected by the Assessee, it was claimed by the Assessee that the price charged by it in the international transaction was at Arm's Length. The Transfer Pricing Officer (TPO) to whom the determination of ALP was referred by the AO, rejected the TP study of the Assessee and he selected 10 companies as comparable companies with the Assessee. A final Set of 10 comparable companies was chosen by the TPO as comparable companies. The arithmetic mean of profit margin of these companies before adjustment towards working capital was 22.63% (Vide Para 8.2) of the TPO'sorder u/s. 92CA of the Act, dated 7.1.2016. Based on the above average arithmetic mean of profit margin of the comparable companies, the TPO computed the ALP of the international transaction of rendering of SWD services by the Assessee to its holding company after providing adjustment on account of working capital differences, as follows:

Computation of arm's length price by the TPO and the adjustment made:

The difference between the price charged by the Assessee and the ALP determined by the TPO viz., Rs. 50,39,13,092/- was added to the total income by the AO.

4. On appeal by the Assessee the CIT (A) excluded one out of the 10 companies chosen by the TPO. Apart from the above, the CIT (A) in exercise of his powers of enhancement held that the Assessee was not entitled to working capital adjustment as allowed by TPO. Aggrieved by the order of the CIT (A), the Assessee is in appeal before the Tribunal.

5. Before us the issues that were pressed for adjudication were (i) exclusion of 4 out of the remaining 9 comparable companies that remain for comparison after the order of CIT (A); (ii) not allowing deduction on account of working capital adjustment to the arithmetic mean of the profit margin of the comparable companies.

6. As far as exclusion of 4 out of 9 comparable companies are concerned, the learned counsel for the Assessee placed reliance on a decision of the ITAT Bangalore Bench in the case of CGI Information Systems & Management Consultants (P.) Ltd. v. Asstt. CIT [2018] 94 taxmann.com 97 (Bang. - Trib.) which was also a decision rendered for AY 2012-13 where the Assessee was a company engaged in rendering soft ware development services such as the Assessee. The very same 10 comparable companies had been chosen by the TPO in the case of the said Assessee also. The 4 companies which were directed to be excluded in the aforesaid decision were (i) Genesys International Corporation Ltd. (ii) Infosys Technologies Ltd., (iii) Larsen & Toubro Infotech Ltd. and (iv) Persistent Systems Ltd.

7. The following were the relevant observations of the Tribunal on the comparability of these companies to a SWD service provider such as the Assessee:

'29. We have considered the rival submissions. In the case of Agilis Information Technologies India (P.) Ltd. (supra), this Tribunal considered the comparability of the 3 companies which the Assessee seeks to exclude from the final list of comparable companies chosen by the TPO. The functional profile of me Assessee and that of the Assessee in the case of Agilis Information Technologies India (P.) Ltd. (supra), is identical inasmuch as the said company was also involved in providing SWD services to its AE and the TPO had chosen some comparable companies which were also chosen by the TPO in the case of the Assessee for the purpose of comparability. In the aforesaid decision the Tribunal held on the comparability of the 3 companies which the Assessee seeks to exclude as follows:

30. Respectfully following the decision of the Tribunal we hold that the aforesaid 3 companies be excluded from the final list of comparable companies for the purpose of arriving at the arithmetic mean of comparable companies for the purpose of comparison with the profit margins. In this regard we are also of the view that the plea of the learned DR for a remand of the issue to the DRP on the ground that the DRP has not given any reasons in its directions cannot be accepted. The DRP bas endorsed the view of the TPO in its directions and therefore the reasons given by the TPO should be regarded as the conclusions of the DRP.

31. The learned DR. next submitted that Genesys International Corporation Ltd., should be excluded from the list of comparable companies. The comparability of this company with the Assessee has been discussed by the TPO in page-11 of his order. The Assessee objected to inclusion of this company in the list of comparable companies for the reason that this company is functionally different and owns intangible assets which are peculiar only when the Assessee owns software products. The objections of the Assessee are contained in its letter dated 22.12.2015 addressed to the TPO and in annexure-B to the said letter. The relevant portion of the objection is at pages 711-713 of the Assessee's paper book. According to the Assessee this company is engaged in providing Geographical Information Services comprising of Photogrammetry, Remote Sensing, Cartography. Data Conversion, state of the art terrestrial and 3D geocontent including location based and other computer based related services. Pagc-38 of the Annual report 2012 containing the above description was brought to the notice of the TPO, Attention of the TPO was invited to the directors report to the shareholders at page ii of the annual report 2012, wherein the Directors have informed the shareholders that the company continued in its journey, to be innovators and leaders in the fields of location based services related geoplatforms and advanced survey techniques. There is no segmental reporting because it is stated in the annual report that this company is only in one segment viz., GIS based services and therefore there is no requirement of segmental reporting. It was also submitted that this company owns substantial intangibles equivalent to 10.42% of its total turnover.

32. The TPO however has regarded this company as a comparable company by observing that this company develops software for mapping and geospatial services and operates a few development centres in India. The company is predominantly into software development services. The intangibles in the possession of the company are only the GIS database which is only depreciation. It does not add significant value to the company.

33. The objections as put forth before the TPO were reiterated before the DRP. The DRP in paragraphs 6.2.2 & 6.2.3 of its directions dealt with this issue as follows;

"6.2.2 The functions of the Assessee company have been examined in detail. A financial product on which the settlement system of bank runs is a real time system. It is very complex. Any bug or problem in it can crash the entire banking system of several nations. The Assessee's claim of providing only basic software services is rejected.

6.2.3 The Panel holds that the software for financial product is much more complex than a geospatial software. Therefore, the panel holds that the Genesys is a valid comparable."

34. The learned counsel for the Assessee submitted that the DRP has completely proceeded on wrong facts which does not either emanate from the order of the TPO or the submissions of the Assessee. He reiterated submissions made before the TPO and DRP. The learned OR relied on the order of the DRP/TPO.

35. We have given a careful consideration to the rival submissions. It is clear from the material brought to the notice of the TPO by the Assessee that this: company renders mapping and geospatial services. In rendering such services it develops software. But that does not mean that this company is in the business of software development. The business profile of this company as per the annual report does not show that this company is into software development service. The only line of business that this company carries on is rendering G1S based services and this is clear from the annual report which specifies that since the company carries on only one line of business viz., GIS based services there is no need to give any segmental results. In the circumstances, we are of the view that there is no basis for the TPO to conclude that this company is predominantly into software-development services. The presence of intangible assets is indicative of the fact that this company is not in software development services business. The TPO has overlooked this aspect and proceeded on the basis that the presence of intangible assets would not be significant. Rule 10B(2) of the Income Tax Rules, 1962 (Rules) specifically provides that for the purposes of sub-rule (1) of Rule 10B, the comparability of an international transaction with an uncontrolled transaction shall be judged with reference to the following, namely:—

In the given facts and circumstances, we are of the view that Genesys International Corporation Ltd., cannot be considered as a comparable company and the said company should be excluded from the final list of comparable companies. We hold accordingly.'

8. The learned DR however submitted that the OP/OC of CGI Information System (supra) was 12.63% whereas the operating profit to Operating cost of the Assessee in the present case is very low at 7.71% and therefore the decision rendered in CGI Information System (supra) should not be applied to the case of the Assessee. We are of the view that this argument is unacceptable because the comparability of companies is based on functions, Assets and risk assumed of the tested party and the comparable companies and not on the basis of profit margin of the Assessee whose international transaction is subject matter of determination of ALP.

9. Another argument advanced by the Assessee was that even the Assessee owns intangible assets and generates IPRs in the course of rendering SWD services and therefore the decision rendered in the case of CGI Information System (supra) is not applicable because in that case the Assessee was not software product company. At the outset we observe that this argument is open only in respect of comparable companies Persistent Systems Ltd., and Larsen & Toubro Infotech Ltd. We find that the ground for exclusion by the Tribunal in the case of CGI Information System (supra) is not only on the ground that these two companies are software product company but also on the ground of want of segmental information regarding SWD services and SW Products. Apart from the above, we find that this was never the case of the TPO that the Assessee was a SW product company. The product life cycle of SWD services is given at page-77 of the Assessee's paper book and it shows that the Assessee does not own IPR in SW developed by it. It may that the IPR of the SWD services are ultimately owned by the wholly owned holding company of the Assessee. That will not make the Assessee a SW product company. We therefore find no merits in this line of argument advanced by the learned DR.

10. The next grievance projected by the Assessee in its appeal is with regard to the action of the CIT (A) in not allowing any adjustment towards working capital differences. On this issue we have heard the rival submissions. The relevant provisions of the Act in so far as comparability of international transaction with a transaction of similar nature entered into between unrelated parties, provides as follows:

Determination of arm's length price under section 92C.

10B. (1) For the purposes of sub-section (2) of section 92C, the arm's length price in relation to an international transaction [or a specified domestic transaction] shall be determined by any of the following methods, being the most appropriate method, in the following manner, namely ;—

(e) transactional net margin method, by which,—

(2) For the purposes of sub-rule (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:-—

(3) An uncontrolled transaction shall be comparable to an international transaction [or a specified domestic transaction]if—

11. A reading of Rule 10B(l)(e)(iii) of the Rules read with Sec.92CA of the Act, would clearly shows that the net profit margin arising in comparable uncontrolled transactions has to 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.

12. Chapters I and III of the OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations (hereafter the "TPG") contain extensive guidance on comparability analyses for transfer pricing purposes. Guidance on comparability adjustments is found in paragraphs 3.47-3.54 and in the Annex to Chapter III of the TPG. A revised version of this guidance was approved by the Council of the OECD on 22 July 2010. In paragraph 2 of these guidelines it has been explained as to what is comparability adjustment. The guideline explains that when applying the arm's length principle, the conditions of a controlled transaction (i.e. a transaction between a taxpayer and an associated enterprise) are generally compared to the conditions of comparable uncontrolled transactions. In this context, to be comparable means that:

13. In Paragraphs 13 to 16 of the aforesaid OECD guidelines, need for working capital adjustment has been explained as follows:

"13. In a competitive environment, money has a time value. If a company provided, say, 60 days trade terms for payment of accounts, the price of the goods should equate to the price for immediate payment plus 60 days of interest on the immediate payment 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 benefitting 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:

14. Examples of how to work out adjustment on account of working capital adjustment is also given in the said guidelines. The guideline also expresses the difficulty in making working capital adjustment by concluding that the following factors have to be kept in mind (i) The point in time at which the Receivables, Inventory and Payables should be compared between the tested party and the comparables, whether it should be the figures of receivables, inventory and payable at the year end or beginning of the year or average of these figures, (ii) the selection of the appropriate interest rate (or rates) to use. The rate (or rates) should generally be determined by reference to the rate(s) of interest applicable to a commercial enterprise operating in the same market as the tested party. The guidelines conclude by observing that the purpose of working capital adjustments is to improve the reliability of the comparables.

15. In the present case the TPO allowed working capital adjustment accepting the calculation given by the Assessee. The CIT (A) in exercise of his powers of enhancement held that no adjustment should be made to the profit margins on account of working capital differences between the tested party and the comparable companies for the following reasons:

16. The CIT (A) also placed reliance on a decision of Chennai ITAT in the case of Mobis India Ltd. v. Dy. CIT [2013] 38 taxmann.com 231/[2014] 61 SOT 40 . 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 companies. If that power is not exercised to find out the truth then it is no defence to say that the Assessee has not furnished the required details and on that score deny adjustment on account of working capital differences. Regarding applying the daily balances of inventory, receivables and payables for computing working capital adjustment, the Delhi Bench of ITAT in the case of ITO v. E Value Serve.com [2016] 75 taxmann.com 195 (Delhi - Trib.) . has held that insisting on daily balances of working capital requirements to compute working capital adjustment is not proper as it will be impossible to carry out such exercise and that working capital adjustment has to be based on the opening and closing working capital deployed. The Bench has also observed that that in Transfer Pricing Analysis there is always an element of estimation because it is not an exact science. One has to see that reasonable adjustment is being made so as to bring both comparable and test party on same footing. Therefore there is little merit in CIT (A)'s objection on working adjustment based on unavailable daily working capital requirements data. There is also no merit in the objection of the CIT (A) regarding absence of segmental details available of working capital requirements of comparable companies chosen and absence of details of trade and non-trade debtors of comparable companies as these details are beyond the power of the Assessee to obtain, unless these details are available in public domain. Regarding absence of cost of working capital funds, the OECD guidelines clearly advocates adopting rate(s) of interest applicable to a commercial enterprise operating in the same market as the tested party. Therefore this objection of the CIT (A) is also not sustainable.

17. In the light of the above discussion we are of the view that the CIT (A) was not justified in denying adjustment on account of working capital adjustment. Since, the CIT (A) has not found any error in the TPO's working of working capital adjustment, the working capital adjustment as worked out by the TPO has to be allowed. We may also add that the complete working capital adjustment working has been given by the Assessee and a copy of the same is at pages 173 & 192 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 CIT (A) 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 CIT (A) 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—

18. In such a scenario there would remain no comparable uncontrolled transactions for the purpose of comparison. The transfer pricing exercise would therefore fail. Therefore in keeping with the OECD guidelines, endeavor should be made to bring in comparable companies for the purpose of broad comparison. Therefore the working capital adjustment as claimed by the Assessee should be allowed. We hold and direct accordingly.

19. In the result, the appeal of the assessee is allowed.

jyoti