ITAT Bangalore: Rs. 200 Crore Turnover Threshold Applied to Exclude Large Software Companies; Receivables Adjustment Remanded for Fresh Examination

Background and Overview

The Bangalore Bench of the Income Tax Appellate Tribunal adjudicated the transfer pricing appeal filed by Quicklogic Software (India) Pvt. Ltd. against the assessment order dated 25/01/2022 passed by the National Faceless Assessment Centre for Assessment Year 2017-18. The appeal was partly allowed, with the Tribunal delivering significant rulings on the exclusion of high-turnover comparables, the remand of certain companies for fresh FAR-based analysis, and the treatment of delayed trade receivables and associated working-capital adjustments.

The assessee, a wholly owned Indian subsidiary of QuickLogic Corporation, USA, was engaged exclusively in rendering software development services to its associated enterprise. For the year under consideration, it declared total income of Rs. 1,58,96,300/- and disclosed international transactions surpassing Rs. 15 crores, which triggered a reference to the Transfer Pricing Officer under Section 92CA of the Income Tax Act, 1961.

International Transactions and Transfer Pricing Methodology

The assessee adopted the Transactional Net Margin Method (TNMM) using Operating Profit to Operating Cost (OP/OC) as the Profit Level Indicator (PLI) for benchmarking its software development services segment. It reported a margin of 11.69% and proposed 16 comparables, yielding an average margin of 9.59%, thereby asserting that its transactions were at arm's length.

The TPO, however, was dissatisfied with the assessee's comparable selection. After applying various filters and rejecting 10 of the assessee's chosen comparables, the TPO independently identified a set of 20 comparables with a weighted average margin of 21.24%. This resulted in a proposed transfer pricing adjustment of Rs. 1,75,34,230/- for the software development segment.

Additionally, the TPO observed outstanding trade receivables from the associated enterprise and proceeded to compute notional interest thereon at a rate of 5.975% (being six-month LIBOR plus 450 basis points), treating the extended credit period as a separate international transaction. This gave rise to a further adjustment of Rs. 24,25,718/-. The aggregate transfer pricing adjustment proposed under Section 92CA thus amounted to Rs. 1,99,59,948/-. Following DRP directions — which partly accepted the assessee's objections and directed inclusion of M/s. Orangescape Technologies Ltd., M/s. Maveric Systems Ltd. and M/s. Inteq Software Pvt. Ltd. in the final comparable set — the Assessing Officer passed the final assessment order incorporating a revised transfer pricing addition of Rs. 1,78,89,497/-.

Functional Profile of the Assessee

The Tribunal noted the TPO's characterisation of the assessee's functional profile before undertaking comparability analysis. The assessee performed the following functions in the software development process:

  • Project Identification — Determining requirements for new or enhanced products
  • Requirement Analysis — Selecting appropriate teams based on skill set and project specifications
  • Configuration Management — Employing internally developed tools for code configuration
  • Tracking — Monitoring development progress through an internal bug-tracking system
  • Design — Preparing design documents aligned with project requirements
  • Implementation — Deploying predefined code sets for project execution
  • Testing — Generating and executing test plans at each development stage
  • Review — Incorporating feedback and review comments at every project stage
  • Release — Following a defined release procedure with change management

The primary assets employed by the assessee were tangible in nature — computer equipment, laboratory and test equipment, office equipment and furniture — with a modest net block of Rs. 28,69,360/-. The assessee did not own any significant non-routine intangibles, holding only internally developed software with a net value of Rs. 4,65,138/-. As regards risks, the assessee assumed foreign exchange risk since it was remunerated in foreign currency, while all other material risks were borne by the US parent. The Tribunal accordingly affirmed the TPO's characterisation of the assessee as a captive service provider remunerated on a cost-plus basis.

Ground No. 1 — Exclusion of High-Turnover Comparables

The Assessee's Position

The assessee sought exclusion of the following comparables on the ground that their turnover far exceeded Rs. 200 crores and rendered them incomparable with a captive entity having a turnover of approximately Rs. 13 crores: