ITO vs Sabre Travel Technologies Pvt. Ltd.

Introduction

This case commentary analyzes a significant ruling by the Income Tax Appellate Tribunal (ITAT), Bangalore Bench, in the case of M/s. Sabre Travel Technologies Pvt. Ltd. vs. Income Tax Officer (IT(TP)A Nos. 403 & 698/Bang/2016) for Assessment Year (AY) 2011-12. The judgment, pronounced on September 4, 2020, addresses critical issues in transfer pricing, particularly the determination of Arm’s Length Price (ALP) for international transactions involving Software Development Services (SWD) and Managed Support Services (MSS). The ITAT’s decision provides clarity on the exclusion of non-comparable companies, the computation of working capital adjustments, and the treatment of expenses under Section 10A of the Income Tax Act, 1961. This commentary delves into the facts, legal reasoning, and implications of the ruling, offering insights for multinational enterprises and tax professionals navigating India’s transfer pricing regime.

Facts of the Case

The assessee, M/s. Sabre Travel Technologies Pvt. Ltd., is engaged in providing SWD services and MSS to its wholly owned holding company, which qualifies as an Associated Enterprise (AE) under Section 92A of the Act. For AY 2011-12, the assessee filed a Transfer Pricing Study (TP Study) adopting the Transaction Net Margin Method (TNMM) as the Most Appropriate Method (MAM) and Operating Profit/Operating Cost (OP/OC) as the Profit Level Indicator (PLI). The assessee identified 13 comparable companies with an average profit margin of 13.71%, claiming its international transactions were at arm’s length.

The Transfer Pricing Officer (TPO), however, rejected several of the assessee’s comparables and selected its own set, resulting in an adjusted mean margin of 26.34% after a working capital adjustment of -1.52%. This led to an ALP adjustment of Rs. 8,22,35,220 for SWD services. The Dispute Resolution Panel (DRP) excluded six companies (e.g., Infosys Ltd., Mindtree Ltd.) using a turnover filter of over Rs. 200 crores but retained five others—Acropetal Technologies Ltd., E-Infochips Ltd., ICRA Techno Analytics Ltd., Persistent Systems & Solutions Ltd., and E-Zest Solutions Ltd.—against the assessee’s objections. The DRP also directed a risk adjustment of 1% without proper quantification, which the Revenue challenged. Additionally, the assessee contested the working capital adjustment computation and the disallowance of certain expenses under Section 10A.

Reasoning of the Tribunal

The ITAT’s reasoning is structured around three core issues: exclusion of comparable companies, working capital adjustment, and corporate tax deductions under Section 10A. Each is analyzed in detail below.

1. Exclusion of Comparable Companies (Assessee’s Ground No. 10)

The Tribunal applied judicial precedent to exclude five companies from the list of comparables, following its earlier decision in M/S. LG Soft India Pvt. Ltd. vs. DCIT (IT(TP)A No. 52/Bang/2016, dated August 5, 2020). The reasoning for each company is as follows:

– Acropetal Technologies Ltd.: The Tribunal held that this company was engaged in the development of computer products, not pure SWD services. Citing Electronic for Imaging (I) Pvt. Ltd. vs. DCIT (2017), the ITAT ruled that functional dissimilarity warrants exclusion.
– E-Infochips Ltd.: The company earned revenue from both software services and products. Although segmental revenue data was available, the break-up of operating costs and net operating revenue was not, making it incomparable.
– ICRA Techno Analytics Ltd.: Following DCIT vs. Ikanos Communication Pvt. Ltd. (ITA 137/Bang/2015), the Tribunal excluded this company because it was engaged in engineering and consulting services, including licensing and sub-licensing, with no segmental information for SWD services.
– E-Zest Solutions Ltd.: The Tribunal, relying on Symantech Software & Services (I) Pvt. Ltd. vs. DCIT (ITA No. 614/Mds/2016), held that this company was a Knowledge Process Outsourcing (KPO) provider, not a SWD services company.
– Persistent Systems & Solutions Ltd.: The Tribunal did not explicitly address this company in the provided text, but the summary indicates it was among the five companies the assessee sought to exclude. The ITAT’s general direction to follow LG Soft India suggests this company was also excluded based on functional non-comparability.

The Tribunal emphasized that comparables must be functionally similar to the assessee, particularly in terms of business activities and risk profiles. This aligns with the arm’s length principle under Section 92C of the Act.

2. Working Capital Adjustment (Assessee’s Ground No. 12)

The assessee challenged the TPO’s computation of working capital adjustment on three grounds: (a) the assessee bore no working capital risk, so a negative adjustment should not apply; (b) the TPO arbitrarily restricted the adjustment without justification; and (c) the TPO used the wrong State Bank of India Prime Lending Rate (SBI PLR). The Tribunal found contradictions in the TPO’s approach:

– Negative Adjustment: The TPO applied a -1.52% adjustment, reducing the comparables’ margin from 24.82% to 26.34%. The assessee argued that since it received advances from its AE, it had no working capital risk. The Tribunal agreed that negative adjustments should not be made when the assessee bears no such risk, as per the principle that adjustments must reflect actual economic realities.
– Arbitrary Restriction: The TPO did not provide a reasoned basis for capping the adjustment. The Tribunal noted that positive adjustments (e.g., for lower working capital risk) should be allowed without arbitrary limits, following the guidance in LG Soft India.
– SBI PLR Error: The assessee contended that the TPO used an incorrect SBI PLR. The Tribunal did not rule on this but remanded the entire issue for fresh computation, directing the TPO to consider advances from AEs as part of payables and to apply a consistent methodology.

The Tribunal’s reasoning underscores that working capital adjustments must be based on a detailed analysis of the assessee’s risk profile and should not be mechanically applied.

3. Revenue’s Appeal on Risk Adjustment (Ground No. 2)

The Revenue challenged the DRP’s direction to allow a 1% risk adjustment without proper quantification. The DRP had merely directed the AO to decide the percentage, citing Hellosoft Pvt. Ltd. (2013). The Tribunal held that this direction was not in accordance with law because there was no discussion on the specific risks or their quantification. Consequently, the Revenue’s ground was allowed, and the risk adjustment issue was set aside for fresh determination.

4. Deduction under Section 10A

The Tribunal upheld the exclusion of telecommunication expenses, insurance charges, and foreign exchange loss from both export turnover and total turnover for computing the Section 10A deduction. This followed the Supreme Court’s rulings in Tata Elxsi Ltd. and HCL Technologies Ltd., which mandate uniform treatment of expenses. The lease rental disallowance was remanded to the AO as it was not part of the draft assessment order, ensuring procedural fairness.

Conclusion

The ITAT’s ruling in Sabre Travel Technologies is a landmark decision that reinforces key principles in transfer pricing and corporate tax. By excluding non-comparable companies based on functional dissimilarity, the Tribunal upheld the arm’s length standard. The remand of the working capital adjustment issue highlights the need for a fact-specific, non-arbitrary approach. On Section 10A, the judgment aligns with Supreme Court precedents, ensuring consistency in tax deductions. This case serves as a vital reference for multinational enterprises, emphasizing the importance of robust benchmarking studies and compliance with judicial precedents. Tax professionals should note the Tribunal’s emphasis on economic substance over mechanical adjustments, which will shape future ALP determinations.

Frequently Asked Questions