2013 (9) TMI 1069 - AT - Income Tax

Transfer pricing adjustment - comparability - Held that - Those companies ( like Infosys and others) are full fledged risk bearing companies and are functionally dissimilar as a comparable to assessee who is a captive software service provider. Addition u/s 14A - Held that - It has not been disputed that no borrowed funds were utilized for investment in mutual funds. Consequently the average cost of investment almost becomes nil. However various courts have held that the investment and consequent earnings have back up of the administrative infrastructure. Keeping in view the same we are inclined to restrict the estimated disallowance u/s 14A in this behalf @ 10% of the dividend i.e. 57, 580/-. This ground is partly allowed.

Summary

Issues Involved:
1. Transfer Pricing (TP) Adjustments
2. Disallowance under Section 14A of the Income-tax Act
3. Charging of Interest under Sections 234A, 234B, 234C, and 234D of the Income-tax Act

Detailed Analysis:

1. Transfer Pricing (TP) Adjustments:

The primary issue revolves around the addition of Rs. 15,842,690/- to the income of the appellant based on the assessment of international transactions related to Contract Software Development (CSD) services. The assessing officer, following the directions of the Dispute Resolution Panel (DRP), confirmed this addition, which was initially proposed by the Transfer Pricing Officer (TPO).

The appellant, a wholly-owned subsidiary of a US-based company, operates as a limited risk-bearing captive service provider, primarily involved in the last three stages of the software development life cycle. The appellant contested the inclusion of certain companies as comparables, arguing they were not functionally similar. The TPO had used arbitrary quantitative and qualitative filters to propose a set of 26 comparables with a mean margin of 32.07%, later adjusted to 19 comparables with a margin of 29.38%.

The DRP directed the exclusion of Celestial Biolabs due to its dissimilar functional profile and rectification of Softsol Limited's operating margin. Despite these directions, the TPO made an adjustment of Rs. 15,842,960, upheld by the assessing officer. The appellant cited a previous ITAT decision excluding certain comparables, which was upheld by the Delhi High Court, asserting these companies were full-fledged risk-bearing entities and not comparable to the appellant, a captive service provider. The Tribunal agreed with the appellant, directing the TPO/AO to exclude the objected comparables and work out the TP adjustment accordingly.

2. Disallowance under Section 14A of the Income-tax Act:

The appellant contested the disallowance of Rs. 106,034/- under Section 14A, related to expenditure incurred for earning exempt income (dividends). The assessing officer applied Rule 8D to make this adjustment, which was confirmed by the DRP. The appellant argued that no borrowed funds were used for the investment, and no administrative expenditure was incurred to earn the dividend income.

The Tribunal noted that no borrowed funds were utilized for the investment in mutual funds, and thus, the average cost of investment was almost nil. However, acknowledging that administrative infrastructure supports such investments, the Tribunal restricted the disallowance to 10% of the dividend income, amounting to Rs. 57,580/-.

3. Charging of Interest under Sections 234A, 234B, 234C, and 234D of the Income-tax Act:

The appellant also contested the mechanical charging of interest under Sections 234A, 234B, 234C, and 234D without satisfactory reasons. The Tribunal held that the charging of interest is consequential and did not provide further relief on this ground.

Conclusion:

The Tribunal partially allowed the appellant's appeal. The TP adjustments were directed to be recalculated by excluding the objected comparables, as per the Delhi High Court's judgment. The disallowance under Section 14A was reduced to 10% of the dividend income, and the charging of interest was held to be consequential.