2013 (1) TMI 773 - AT - Income Tax

Transfer pricing adjustments - calculation of ALP and selection of comparables - Held that - Assessees engaged in software development services business - 8 comparables are to be rejected from the TPO s list on account of the turnover filter - that 5 companies are to be excluded on account of functional dissimilarity - Turnover filter - the size of the comparable is an important factor in comparability - when companies which are loss making are excluded from comparables then the super profit making companies should also be excluded - TPO is directed to take segmental margins of 23.11% for comparability - ordered accordingly Related Party transaction - an entity can be taken as uncontrolled if its related party transactions do not exceed 10 to 15% of total revenue - cannot be said to have significant influence the profitability of the comparables - TPO is directed to exclude after due verification those comparables from the list with the related party transactions or controlled transactions in excess of 15% of the total revenue - Ordered accordingly - Decided partly in favor of assessee

Issues Involved:
1. Transfer Pricing Adjustment
2. Deduction under Section 10A of the Income Tax Act

Detailed Analysis:

I. Transfer Pricing Adjustment

Facts:
The assessee company, a wholly-owned subsidiary of a UK-based company, engaged in software development services, entered into international transactions with its associated enterprise (AE) in the financial year 2006-07. The transactions included the provision of software development services amounting to Rs. 27.74 crores. The Transfer Pricing Officer (TPO) made an adjustment of Rs. 3,77,22,565/- to the Arm's Length Price (ALP).

Assessee's Methodology:
The assessee used the Transaction Net Margin Method (TNMM) and selected 17 comparable companies, arriving at an operating margin of 13.22%, which included foreign exchange fluctuation gains. The arithmetical mean of the comparables' net margin was 10.86%.

TPO's Methodology:
The TPO selected 26 comparables and computed an arithmetical mean of 24.71% after working capital adjustments, leading to an adjustment of Rs. 3,77,22,565/-.

Issues Raised by the Assessee:
1. Use of Multiple Year Data: The TPO's rejection of multiple-year data due to non-availability of current year data in the public domain.
2. Section 133(6) Recourse: The TPO's use of Section 133(6) without providing an opportunity for cross-examination.
3. Related Party Transactions Filter: The TPO's application of a 25% filter for related party transactions, whereas the Tribunal in other cases had fixed a reasonable limit of 15%.
4. Turnover Filter: The TPO's failure to apply an upper limit to the sales turnover.
5. Selection of Comparables with High Margins: The TPO's selection of comparables with abnormally high margins.
6. Functionally Dissimilar Comparables: The TPO's selection of functionally dissimilar comparables.
7. Onsite Turnover Filter: The TPO's application of an onsite turnover filter of >75%.
8. Foreign Exchange Fluctuation Gains: The TPO's exclusion of foreign exchange fluctuation gains from operating revenues.

Tribunal's Findings:

1. Turnover Filter:
- The Tribunal emphasized the importance of the size of the comparable companies, referencing the ICAI TP guidance note and previous Tribunal decisions. Companies with turnover exceeding Rs. 200 crores were excluded, including Infosys Technologies Ltd., Wipro Ltd., and others.

2. Functional Dissimilarity:
- The Tribunal excluded Accel Transmatic Ltd., Avani Cimcon Technologies Ltd., Celestial Labs Ltd., KALS Information Systems Ltd., and Lucid Software Ltd. from the list of comparables due to functional dissimilarity, referencing previous Tribunal decisions.

3. Related Party Transactions:
- The Tribunal directed the exclusion of companies with related party transactions exceeding 15% of total revenues, following the decision in the case of 24/7 Customer Com Private Ltd.

4. Foreign Exchange Gain/Loss:
- The Tribunal directed that foreign exchange gains or losses should be considered as part of operating revenue or cost for both the assessee and the comparable companies, following the decision in the case of Trilogy E-Business.

Conclusion:
The Tribunal directed the Assessing Officer/TPO to recompute the ALP in accordance with its directions and make adjustments if the differential margin exceeded the permissible 5% bandwidth.

II. Deduction under Section 10A of the Act

Facts:
The assessee claimed a deduction under Section 10A amounting to Rs. 3,19,98,038/-. The Assessing Officer reduced telecommunication expenses from the export turnover but did not make a corresponding exclusion from the total turnover, resulting in a reduced deduction.

Assessee's Argument:
The assessee cited the judgment of the Karnataka High Court in the case of CIT v Tata Elxsi Ltd., which held that expenses reduced from export turnover should also be reduced from total turnover to maintain parity.

Tribunal's Findings:
The Tribunal directed the Assessing Officer to reduce the telecommunication expenses from both the export turnover and the total turnover while computing the deduction under Section 10A, in line with the Karnataka High Court's judgment.

Conclusion:
The assessee's appeal was partly allowed, with directions to recompute the deduction under Section 10A accordingly.

Final Decision:
The appeal was partly allowed, with specific directions to the Assessing Officer/TPO on the issues of transfer pricing adjustment and deduction under Section 10A.

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