Negative working capital adjustment shall not be made in case of a captive service provider

Lam Research (India) Pvt. Ltd. Vs DCIT (ITAT Bangalore)

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 does not bear any risk and has no working capital contingencies. The Assessee has not incurred any expenses for meeting the working capital requirement. The Assessee is running the business without any working capital risk as compared to the comparables. The Assessee does not bear any market risk as the services are provided only to Tavant US. Therefore, requirement for adjustment of negative working capital does not arise.

We have considered the rival submissions. We find that in the case of Lam Research India (P.) Ltd. (supra) and Software AG Bangalore Technologies (P.) Ltd. (supra) passed by this Tribunal, it has been held that negative working capital adjustment shall not be made in case of a captive service provider as there is no risk and it is compensated on a total cost plus basis. We therefore direct Ld.TPO to compute the ALP in accordance with the directions contained in this order after affording assessee opportunity of being heard.

FULL TEXT OF THE ITAT JUDGEMENT

Present appeal has been filed by assessee against final assessment order dated 22/09/2017 passed by Ld.DCIT Circle 4 (1) (1), Bangalore for assessment year 2013-14 on following grounds of appeal:

“Based on the facts and circumstances of the case and in law, Lam Research (India) Private Limited (hereinafter referred to as Appellant’), respectfully craves leave to prefer an appeal against the assessment order passed by the learned Assessing Officer [hereinafter referred to as the learned AO] under section 143(3) read with section 1440 of the Income-tax Act., 1961 (the Act’) on the following grounds:

1. The learned AO/Transfer Pricing Officer (‘TPO’) and the learned DRP have erred, in law and in facts, by making an addition of Rs 1,36,50,206 to the total income of the Appellant on account of adjustment to the arm’s length price of the software development services transaction entered into by the Appellant with its associated enterprise;

2. The learned AO / TPO and the learned DRP have erred, in law and in facts, by not accepting the economic analysis undertaken by the Appellant in accordance with the provisions of the Act read with the Income Tax Rules, 1962 (‘Rules’), conducting a fresh economic analysis for the determination of the ALP in connection with the impugned international transaction, and holding that the Appellant’s international transaction is not at arm’s length;

3. The learned AO / TPO have erred, in law and in facts, by exercising his powers under section 133(6) of the Act to obtain information which was not available in public domain and relying on the same for comparability purposes;

4. The learned AO / TPO and the learned DRP have erred, in law and in facts, by determining the arm’s length margin/ price using data pertaining only to FY 2012-13 which was not available to the Appellant at the time of complying with the transfer pricing documentation requirement;

5. The learned AO/TPO and the learned DRP have erred, in law and facts by rejecting certain comparable companies considered by the Appellant in the comparability analysis by applying different quantitative and qualitative filters:

i. The learned AO I TPO and the learned DRP have erred, in law and in facts, by rejecting certain comparable companies identified by the Appellant for having different accounting year (i.e. companies having accounting year other than March 31 or companies whose financial statements were for a period other than 12 months);

ii. The learned AO I TPO and the learned DRP have erred, by rejecting certain comparable companies identified by the Appellant using employee cost greater than 25% of the total revenues as a comparability criterion;

iii. The learned AO / TPO and the learned DRP have erred, in law and in facts, by rejecting certain comparable companies identified by the Appellant using export earnings greater than 75% of the sales as a comparability criterion;

iv. The learned AO I TPO and the learned DRP have erred, in law and in facts, in applying only the lower cap on the turnover filter of Rs.1 crore and not applying any upper cap for the comparability criterion;

6. The learned AO/ TPO and the learned DRP have erred, in law and in facts, by accepting rejecting companies based on unreasonable comparability criteria;

7. The learned AO / TFO and the learned DRP have erred, in law and in facts, by providing an adverse working capital adjustment without appreciating the fact that the Appellant is a captive service provider;

8. The learned AO / TPO and the learned DRP have erred, in law and facts, by not making suitable adjustments to account for differences in the risk profile of the Appellant vis-à-vis the comparable companies;

9. The learned AO has erred, in law and facts, by not considering the Self-Assessment Tax amounting to Rs.4,78,1 11 paid by the Appellant;

10. The learned AO has erred, in law and facts, in imposing interest under section 234B and section 2340 of the Act;

11. The learned AO has erred, in law and in facts, by initiating penalty proceedings u/s 271(1)(c) of the Act.

The Appellant submits that each of the above grounds is independent and without prejudice to one another.

The Appellant craves leave to add, alter, amend, vary, omit or substitute any of the aforesaid grounds of appeal at anytime before or at the time of hearing of the appeal, so as to enable the Hon’ble Tribunal to decide on the appeal in accordance with the law.”

Brief facts of the case are as under:

2. The Assessee in engaged in the business of provision of Software Development Services (SWD services), to its wholly owned holding company. In terms of the provisions of section 92A of the Act, the Assessee and its wholly owned holding company were Associated Enterprises (“AEs”). In terms of sec.92B(1) of the Act, the transaction of providing SWD Services and ITeS were “international transaction” i.e., a transaction between assessee and the associated enterprise, the details of which are as under:

3. In terms of ITES services there has been no dispute between revenue and assessee. The only disputed segment is software development service segment.

4. TPO observed that assessee had following functions under the software development service segment:

2.2. Functional Analysis of the Taxpayer:
Software development services:

• Lam India is engaged in the rendition of software development services to Novellus US. It assists with the design, development, and improvement of Novellus products.
• Novellus US. (“SDG US”) is responsible for developing the embedded software that in Novellus Group products that comprise the semiconductor chip marketing machinery. It focuses on three distinct areas in software development, comprising of:

1. Software related to equipment;

2. Software for proteus graphic user interface group; and

3. Product specific software.

• Lain India also supports the testing of the Software Product builds made by the SDG US/India.
• SPS Group is engaged in providing on-line product support to customers of Novellus machinery in the US, Japan, Korea, Taiwan and Europe.

IT Enables (CAD/CAM) Services

• Lam India is engaged in rendering IT enabled services in the nature of CAD/CAM, to Novellus US.
• Lam India provides technical resolutions for QNs and supports Novellus US in creating ACOs in Wind-chill PLM system, based on design change requirements.
• Lam India supports Novellus US in terms of engineering documentation using CAD tools like pro/Engineer, Auto CAD and Interlink for specific engineering tasks based on the requirements of Novellus US.
• Lam India has also entered into an agreement with Novellus US to render SAP maintenance and enhancement services.

5. The Ld.TPO observed that assessee has used TNMM as most appropriate method with OP/OC as PLI. It computed its margin at 13.96%.Assessee used following 7 comparables with an average of 13.78%.

6. Ld.TPO did not approve the selection criteria of comparables by assessee. The Ld.TPO on his own identified five companies as comparable with the Assessee company and worked out the average arithmetic mean of their profit margins as follows:

7. The Ld.TPO proposed the adjustment to ALP being shortfall at Rs.1,36,50,206/-.

8. The Assessee filed objections before the Disputes Resolution Panel (DRP) against the draft assessment order passed by the Ld.AO wherein the addition suggested by the Ld.TPO as adjustment to ALP was added to the total income of the assessee by the Ld.AO. The Assessee filed objections before the DRP and the DRP gave certain directions. Based on the directions of the DRP, the Ld.AO passed the final order of assessment. To the extent the Assessee did not get relief from the DRP, the assessee has preferred appeal before this Tribunal.

9. At the time of hearing, the Ld.AR submitted that grounds 6(i), 6.2 & 7 were only pressed.

10. The Ld.AR submitted that Grounds 9-11 were consequential in nature.

Accordingly arguments were raised only in respect of following grounds adjudicated herein above.

Ground No. 6.1:

11. AR submitted that except for CG Vak software exports Ltd and ICRA Techno Analytics Ltd, other comparables have been disputed by assessee on turnover filter. It has been submitted that Ld.TPO while applying the turnover filter failed to apply the upper limit of Rs.200 crores. He thus submitted that, following comparables have turnover more than 200 crores and therefore deserves to be excluded:

RS software (India) Pvt.Ltd.

Mindtree Ltd.

Larsen and Toubro Infotech Ltd.

Persistent Systems Ltd.

Tech Mahindra Ltd.

12. On the contrary, Ld.CIT.DR relied on orders passed by authorities below.

13. We have perused submissions advanced both sides in light of records placed before us.

14. One of the arguments by the assessee before the Ld.TPO as well as DRP was that these companies had turnover which was in excess of Rs. 200 crores and therefore these companies cannot be regarded as a comparable in the case of the assessee whose turnover was only Rs. 18 crores. The Ld.TPO as well as DRP took the view that the functional comparability of the companies were alone to be seen and turnover was not an important criterion. In ground No. 5(iv), the assessee has challenged the order of DRP in holding that higher turnover is not a relevant criterion for disregarding a company, when it is functionally found to be comparable. The question boils down on application of turnover filter in choosing comparable companies. As far as excluding the companies on the basis of turnover is concerned, the issue has been settled in several decisions of the Tribunal and has been elaborately discussed by this Tribunal in the case of Autodesk India (P.) Ltd. v. Dy. CIT [2018] 96 taxmann.com 263. This Tribunal in case of Autodesk India (P.) Ltd. v. Dy. CIT (supra) decision after review of entire case laws on the subject, considered the question, whether companies having turnover more than 200 crores to 500 crores has to be regarded as one category and those companies cannot be regarded as comparables with companies having turnover of less than 200 crores, the Tribunal held as follows:—

“17.7 We have considered the rival submissions. The substantial question of law (Question No. 1 to 3) which was framed by the Hon’ble Delhi High Court in the case of Chryscapital Investment Advisors (India) Pvt. Ltd., (supra) was as to whether comparable can be rejected on the ground that they have exceptionally high profit margins or fluctuation profit margins, as compared to the Assessee in transfer pricing analysis. Therefore as rightly submitted by the learned counsel for the Assessee the observations of the Hon’ble High Court, in so far as it refers to turnover, were in the nature of obiter dictum. Judicial discipline requires that the Tribunal should follow the decision of a non-jurisdiction High Court, even though the said decision is of a non-jurisdictional High Court. We however find that the Hon’ble Bombay High Court in the case of CIT v. Pentair Water India Pvt. Ltd. Tax Appeal No. 18 of 2015 judgment dated 16-9-2015 has taken the view that turnover is a relevant criterion for choosing companies as comparable companies in determination of ALP in transfer pricing cases. There is no decision of the jurisdictional High Court on this issue. In the circumstances, following the principle that where two views are available on an issue, the view favourable to the Assessee has to be adopted, we respectfully follow the view of the Hon’ble Bombay High Court on the issue. Respectfully following the aforesaid decision, we uphold the order of the DRP excluding 5 companies from the list of comparable companies chosen by the TPO on the basis that the 5 companies turnover was much higher compared to that the Assessee.

17.8 In view of the above conclusion, there may not be any necessity to examine as to whether the decision rendered in the case of Genisys Integrating (supra) by the ITAT Bangalore Bench should continue to be followed. Since arguments were advanced on the correctness of the decisions rendered by the ITAT Mumbai and Bangalore Benches taking a view contrary to that taken in the case of Genisys Integrating (supra), we proceed to examine the said issue also. On this issue, the first aspect which we notice is that the decision rendered in the case of Genisys Integrating (supra) was the earliest decision rendered on the issue of comparability of companies on the basis of turnover in Transfer Pricing cases. The decision was rendered as early as 5-8-2011. The decisions rendered by the ITAT Mumbai Benches cited by the learned DR before us in the case of Willis Processing Services (supra) and Capegemini India Pvt. Ltd. (supra) are to be regarded as per incurium as these decisions ignore a binding coordinate bench decision. In this regard the decisions referred to by the learned counsel for the Assessee supports the plea of the learned counsel for the Assessee. The decisions rendered in the case of M/S.NTT Data (supra), Societe Generale Global Solutions (supra) and LSI Technologies (supra) were rendered later in point of time. Those decisions follow the ratio laid down in Willis Processing Services (supra) and have to be regarded as per incurium. These three decisions also place reliance on the decision of the Hon’ble Delhi High Court in the case of Chriscapital Investment (supra). We have already held that the decision rendered in the case of Chriscapital Investment (supra) is obiter dicta and that the ratio decidendi laid down by the Hon’ble Bombay High Court in the case of Pentair (supra) which is favourable to the Assessee has to be followed. Therefore, the decisions cited by the learned DR before us cannot be the basis to hold that high turnover is not relevant criteria for deciding on comparability of companies in determination of ALP under the Transfer Pricing regulations under the Act. For the reasons given above, we uphold the order of the CIT(A) on the issue of application of turnover filter and his action in excluding companies by following the ratio laid down in the case of Genisys Integrating (supra).”

15. In the light of the aforesaid decision of the Tribunal, comparables sought for exclusion in Ground No.6.1 raised by the assessee is allowed.

Accordingly this ground stands allowed partly .

Ground No. 6.2

16. Assessee seeks inclusion of only 1 comparable being, Akshay Software Technologies Ltd. It has been submitted that, the Ld.TPO and DRP accepted this comparable in the final list in previous years, however for the year under consideration the same has been excluded. Ld.AR placed reliance on coordinate bench of this Tribunal in case of M/s NXP India Pvt Ltd. vs DCIT in IT(TP)A No. 692 & 2861/B/2017 for assessment year 2012-13 and 2013-14.

17. On the contrary, the Ld.CIT.DR submitted that DRP for excluding this comparable during the year under consideration has held that the on-site revenue filter of this comparable is less than 75% and hence rejected it from the finalist. He submitted that in the preceding years this observation was not recorded by the authorities below and hence factually cannot be considered identical.

18. In the reply by the Ld.AR, it was submitted that is in the decision relied in case of M/s NXP India Pvt Ltd. vs DCIT (supra) this Tribunal had analysed this aspect of on-site revenue filter in the following manner:

“IV Akshay software technologies Ltd32.

32. It was rejected by the TPO for the reason that the function of this company appears to be more in the nature of support services and I T enabled services. However this company is engaged in providing professional services, implementation, support and maintenance of ERP products and other services. These are nothing but software development services, as is evident from the notes forming part of financial statements which is placed in paper book at page 1825. Further the revenue from software services accounts for 99.45% of the total revenue of the company is evident from the financial statements placed on record of paper book at page No. 1831. Being so, we direct TPO to consider this company as comparable to assessee’s case while selecting the comparables.”

19. Based on the above observation the objection raised by DRP cannot be upheld.

Accordingly we direct Ld. AO/TPO to consider this comparable the finalist.

20. Ground No. 7 alleged by assessee is against providing negative working capital adjustment without appreciating the fact that assessee is a captive service provider.

The grievance of the assessee is with regard to negative working capital adjustment carried out by the Ld.TPO which was confirmed by the DRP. It is the plea of the assessee that though the Ld.TPO has observed that the Assessee has a healthy margin, the Ld.TPO has erred in making an adjustment towards working capital and the DRP further erred in upholding the same.

21. 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 does not bear any risk and has no working capital contingencies. The Assessee has not incurred any expenses for meeting the working capital requirement. The Assessee is running the business without any working capital risk as compared to the comparables. The Assessee does not bear any market risk as the services are provided only to Tavant US. Therefore, requirement for adjustment of negative working capital does not arise.

22. The Ld.AR placed reliance on decision of coordinate bench of this Tribunal in assessee’s own case reported in (2020) 120 com 122 and Lam Research India (P.) Ltd. v. Dy. CIT in [IT Appeal Nos. 1473 & 1385 (Beng.) of 2014, dated 30-4-2015], Tivo Tech (P.) Ltd. v. Dy. CIT [2020] 117 taxmann.com 259, and Dy. CIT v. Software AG Bangalore Technologies (P.) Ltd. [IT Appeal No. 1628 of 2014, dated 31-3-2016], where it has been held that negative working capital adjustment shall not be made.

23. We have considered the rival submissions. We find that in the case of Lam Research India (P.) Ltd. (supra) and Software AG Bangalore Technologies (P.) Ltd. (supra) passed by this Tribunal, it has been held that negative working capital adjustment shall not be made in case of a captive service provider as there is no risk and it is compensated on a total cost plus basis. We therefore direct Ld.TPO to compute the ALP in accordance with the directions contained in this order after affording assessee opportunity of being heard.

Accordingly ground No. 7 raised by assessee stands allowed for statistical purposes.

Ground No. 9-11 are consequential in nature and therefore do not require adjudication.

24. Assessee has not pressed ground 1-4, ground 5 (i)-(iii), ground 6.1 (c )& (g) and ground 6.2 (b)-(j) and ground 8. Accordingly these grounds stands dismissed.

In the result appeal filed by assessee stands partly allowed as indicated hereinabove.

Order pronounced in the open court on 3^rd February, 2021