2015 (5) TMI 1075 - AT - Income Tax

Transfer pricing adjustment - selection of comparability - Held that - A comparable having a different accounting year cannot be a valid comparable. In the case under consideration the assessee is following financial year ending whereas the comparable chosen by the TPO is having calendar year ending. Megasoft Ltd. cannot be taken as a valid comparable for software development company thus should be excluded from the comparables. As far as KLAS Information Systems Ltd. is concerned it is found that company has revenue s from software products as well as software development whereas the assessee is engaged in the business of software development only. We therefore agree with the assessee that the company i.e. KLAS Information Systems is not a good comparable. If both these comparables are taken out of the list of the TPO the profit margin in case of the assessee comes within the permissible range and no upward adjustment would be required to be made. The nature of the service provided by Autodesk India Pvt. Ltd. were of different nature as compared to the services rendered by the assessee. Considering the facts and circumstances of the case effective ground of appeal is decided in its favour and additional ground is allowed for statistical purposes

Issues Involved:
1. Legality and fairness of the assessment order.
2. Rejection of the assessee's benchmarking analysis and selection of comparables.
3. Application of inappropriate filters in the benchmarking search.
4. Consideration of companies with high turnover as comparables.
5. Selection of non-comparable companies due to various factors.
6. Computation of operating margins of comparable companies.
7. Treatment of foreign exchange gain/loss as a non-operating item.
8. Risk profile adjustments for the assessee.
9. Computation of interest under sections 234B and 234C of the Act.

Detailed Analysis:

1. Legality and Fairness of the Assessment Order:
The assessee challenged the assessment order dated October 11, 2010, passed under section 143(3) read with section 144C of the Income-tax Act, 1961. The assessee argued that the order was not in accordance with the law and violated principles of equity and natural justice.

2. Rejection of Benchmarking Analysis and Selection of Comparables:
The Transfer Pricing Officer (TPO) rejected the detailed benchmarking analysis conducted by the assessee without adequate reasons and embarked on a fresh search for comparables. The TPO accepted only two out of the seven comparables selected by the assessee and introduced eighteen new comparables, leading to a dispute over the comparables' selection.

3. Application of Inappropriate Filters in Benchmarking Search:
The TPO applied inappropriate filters in the benchmarking search, which was upheld by the Dispute Resolution Panel (DRP) and the Assessing Officer (AO). The assessee contended that the filters used were not suitable for the nature of its business.

4. Consideration of Companies with High Turnover as Comparables:
The TPO considered companies with very high turnover as comparables to the assessee, which was contested by the assessee. The assessee argued that such companies were not functionally comparable due to significant differences in scale and operations.

5. Selection of Non-Comparable Companies:
The TPO selected companies that were not comparable to the assessee due to factors such as functional differences, product-led revenues, high levels of related party transactions, and inadequate financial information. The assessee specifically contested the inclusion of KALS Info Systems Ltd. and Megasoft Ltd. as comparables.

6. Computation of Operating Margins:
The TPO computed the operating margins of the comparable companies at higher levels, which was upheld by the DRP and the AO. The assessee argued that the profit margin should be within the allowable range of (+/-) 5% as per the provisions of the Act.

7. Treatment of Foreign Exchange Gain/Loss:
The TPO treated foreign exchange gain/loss as a non-operating item, which was contested by the assessee. The assessee argued that such gains/losses should be considered part of the operating income/expenses.

8. Risk Profile Adjustments:
The AO and DRP did not grant adjustments for the differences in the risk profile, considering that the assessee, being a captive service provider operating under a cost-plus arrangement, carried a much lower risk compared to the comparable companies.

9. Computation of Interest under Sections 234B and 234C:
The assessee contested the computation of interest under sections 234B and 234C of the Act, arguing that it was wrongly computed.

Judgment Analysis:
The Tribunal found that the only dispute was about the adjustment made for the international transaction entered into by the assessee with its Associated Enterprises (AE). The Tribunal noted that if two of the comparables, KALS Info Systems Ltd. and Megasoft Ltd., were excluded, the profit margin would be within the permissible range, and no upward adjustment would be required.

The Tribunal held that a comparable having a different accounting year could not be a valid comparable. It was noted that the assessee followed the financial year ending, whereas the comparable chosen by the TPO followed the calendar year ending. The Tribunal also found that software development service provider companies could not be compared with product companies.

Consequently, the Tribunal excluded Megasoft Ltd. and KALS Info Systems Ltd. from the list of comparables. This brought the profit margin within the permissible range, and no upward adjustment was required. The appeal filed by the assessee was allowed, and the additional ground was allowed for statistical purposes.

Conclusion:
The Tribunal allowed the appeal filed by the assessee, holding that the comparables selected by the TPO were not appropriate. The Tribunal excluded KALS Info Systems Ltd. and Megasoft Ltd. from the list of comparables, resulting in the profit margin falling within the permissible range, thus negating the need for an upward adjustment. The order was pronounced in the open court on May 18, 2015.

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