2016 (1) TMI 1277 - AT - Income Tax

Transfer pricing adjustment - computing deduction u/s 10A - Held that - If export turnover in the numerator was to be arrived at after excluding certain expenses the said expenses should also be excluded in computing total turnover in the denominator as export turnover was but a component of total turnover. Therefore the CIT(A) correctly allowed this ground of appeal and directed the AO to exclude from the assessee s total turnover the communication expenses and foreign currency travel expenses which he has already excluded from the export turnover and to accordingly modify the computation of relief allowable u/s 10A. See CIT vs. Tata Elxsi Ltd. 2014 (9) TMI 1013 - KARNATAKA HIGH COURT . Comparable selection - Held that - We are of the opinion that (i) Flextornics Software (ii) iGate Global Solutions Ltd. (iii) Infosys Technologies Ltd. (iv) Persistent Systems Ltd. (v) Sasken Communications where turnover is more than Rs. 200 crores is to be rejected as comparable to that of the assessee. We find that Tata Elxsi Ltd. and Wipro Ltd. are not only having a turnover of more than Rs. 200 crores but are also functionally different as pointed out by the learned counsel for the assessee and hence cannot be taken as a comparable to that of the assessee. We uphold the order of the CIT(Appeals) in directing the AO to include Maars Software International Ltd. as a comparable. The assessee provides software development services which include embedded and network management technical documentation system verification test and associated hardware design for the products developed by Infinera Corp. thus companies disimilar with that of assessee need to be deselected.

Issues Involved:
1. Exclusion of communication and travel expenses from total turnover for computing deduction under Section 10A.
2. Application of turnover filter in selecting comparables for Transfer Pricing.
3. Rejection of certain companies as comparables based on functional dissimilarity and turnover.
4. Use of diminishing revenue filter and different year ending filter.
5. Inclusion of Maars Software International Ltd. and VMF Soft Tech Ltd. as comparables.
6. Exclusion of Bodhtree Consulting Ltd., Celestial Labs, and Lucid Software Ltd. as comparables.

Detailed Analysis:

1. Exclusion of Communication and Travel Expenses from Total Turnover:
The assessee argued that communication expenses (internet charges) and foreign currency travel expenses should be excluded from both export turnover and total turnover when computing the deduction under Section 10A. The CIT(A) agreed, citing the Karnataka High Court's decision in CIT vs. Tata Elxsi Ltd., which mandated that if such expenses are excluded from export turnover, they must also be excluded from total turnover. The Tribunal upheld this view, confirming the CIT(A)'s order and dismissing the department's grounds on this issue.

2. Application of Turnover Filter in Selecting Comparables:
The Tribunal considered the application of the turnover filter in selecting comparables for Transfer Pricing. The assessee's turnover was Rs. 47.46 crores, and it was argued that companies with turnovers exceeding Rs. 200 crores should be excluded as comparables. The Tribunal referred to its earlier decision in Trilogy E-Business Software India Pvt. Ltd. and other cases, establishing that companies like Flextronics Software, iGate Global Solutions, Infosys Technologies, Persistent Systems, Sasken Communication Technologies, Tata Elxsi, and Wipro Ltd., with turnovers exceeding Rs. 200 crores, should be excluded from the list of comparables.

3. Rejection of Certain Companies as Comparables:
The Tribunal addressed the exclusion of certain companies based on functional dissimilarity and turnover. Companies such as Tata Elxsi Ltd. and Wipro Ltd. were excluded not only due to their high turnover but also because they were functionally different from the assessee. The Tribunal upheld the CIT(A)'s decision to exclude these companies from the list of comparables.

4. Use of Diminishing Revenue Filter and Different Year Ending Filter:
The CIT(A) rejected the TPO's use of the diminishing revenue filter, stating that revenue is not a true indicator of a company's performance. The Tribunal upheld this view, noting that a company with diminishing revenue could still have a good profit margin through cost efficiency. The CIT(A) also allowed comparables with different financial year endings within a six-month frame, as permitted by AS-21 and Section 212 of the Companies Act, which the Tribunal affirmed.

5. Inclusion of Maars Software International Ltd. and VMF Soft Tech Ltd. as Comparables:
The CIT(A) included Maars Software International Ltd. as a comparable, rejecting the TPO's employee cost filter. The Tribunal upheld this inclusion, noting that employee costs are not a reliable filter under the TNMM method. Similarly, VMF Soft Tech Ltd. was included as a comparable, as its export revenue was correctly calculated to be 97% of total revenue, contrary to the TPO's erroneous computation. The Tribunal confirmed this inclusion.

6. Exclusion of Bodhtree Consulting Ltd., Celestial Labs, and Lucid Software Ltd. as Comparables:
The Tribunal excluded Bodhtree Consulting Ltd. due to its hybrid business model involving software products, following the decision in Cisco Systems India Pvt. Ltd. Celestial Labs was excluded for being functionally dissimilar, as it was involved in bio-informatics and product development in biotechnology and pharmaceuticals, consistent with the Tribunal's previous decisions. Lucid Software was excluded for being a product development company, following the Tribunal's decision in 3DPLM Software Solutions Ltd.

Conclusion:
The Tribunal partly allowed the department's appeal and dismissed the assessee's Cross Objection. The significant outcomes included the exclusion of high-turnover and functionally dissimilar companies from the list of comparables, the inclusion of companies like Maars Software International Ltd. and VMF Soft Tech Ltd., and the affirmation of the CIT(A)'s decisions on various filters and adjustments.

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