2016 (8) TMI 1243 - AT - Income Tax

Transfer Pricing Adjustment on account of provision of contract research and testing services - comparability analysis - Held that - It is true that under the TNMM broad parameters of transactions and functions are to be seen, but the scrutiny on FAR analysis has to be done vis- -vis the comparable companies. We find that the Tribunal in assessee s own case in the AY 2007-08, so far as three comparables are concerned which are subject matter of dispute before us, viz., Celestial Labs Ltd., IDC (India) Ltd. and Mindtree Ltd. (Segmental), has threadbare analyzed the functions and other comparability parameters of the assessee vis-a-vis the comparable companies and has given a concrete conclusion for exclusion. The Tribunal first of all has analyzed the services and functions carried out by the assessee and, thereafter have analyzed the various comparables for accepting and rejecting the same. So far as the inclusion of M/s Transgene Biotek Limited, we are not entering into merits of the said comparable because no strong reasons have been given by the assessee as to why same was included in the comparability list in the assessment year 2007-08 and why it has been excluded in this year. Since the Ld. Counsel has submitted that, if the three comparables are excluded then the arithmetic mean of the final comparable would be 20.82% and in that case, the resultant arithmetic mean will fall 5% range, therefore, we direct the TPO/AO to examine the working of 5% margin range, after excluding the three comparables from the final list of comparables. Disallowance of Microsoft License fee - revenue v/s capital expenditure - Held that - Without these software, it is difficult to carry out the functioning of the business properly and efficiently, specifically in the case of the assessee whose entire operation of business is carried out through computers. The test of enduring benefit cannot be conclusive test which should be applied in each and every case. What is required to be examined or seen is the real intent and purpose of expenditure and whether such expenditure results in creation of a fixed capital for the assessee. Before us, the Ld. Counsel had brought out that, the computers were already bought and used in the business and the licensed software were installed to make the running of the computers more efficiently. Thus, this expenditure has enabled the operation of the assessee s business effectively and properly, that is, the profit making apparatus to work more efficiently. It does not have any impact on the sources of the business. If certain expenses are incurred which may have enduring benefit of 2 to 3 years, for smooth running of the business operation leaving the fixed assets untouched then, same has to be reckoned as revenue expenditure. - Decided in favour of assessee.

Summary

Issues Involved:
1. Determination of the arm's-length price (ALP) for the appellant's international transactions.
2. Disregard of the appellant's Transfer Pricing (TP) documentation.
3. Use of financial data of only the current year for benchmarking.
4. Rejection of a comparable company due to significant related party transactions.
5. Identification of functionally non-comparable companies.
6. Granting of ±5% benefit under the proviso to Section 92C(2) of the Act.
7. Treatment of software license fees as capital expenditure.
8. Addition to the total income due to the above treatment.

Detailed Analysis:

1. Determination of ALP for International Transactions:
The appellant's international transaction of contract research and testing services was initially determined at ?447,599,531. However, the Assessing Officer (AO) adjusted this to ?480,668,153. The appellant argued that the Transfer Pricing Officer (TPO) included four additional comparables that were not functionally similar to the appellant's activities. The Tribunal, following its earlier decision for the assessment year 2007-08, excluded three of these comparables (Celestial Labs Ltd., IDC (India) Ltd., and Mindtree Ltd. - Segmental) due to their diversified operations and functional dissimilarity. The Tribunal directed the AO/TPO to re-examine the working of the ±5% margin range after excluding these comparables.

2. Disregard of TP Documentation:
Grounds 2, 3, and 4 were not pressed by the appellant and were dismissed as not pressed.

3. Use of Financial Data of Only the Current Year:
This issue was also not pressed by the appellant and thus dismissed.

4. Rejection of Comparable Due to Related Party Transactions:
The TPO rejected Neeman Medical Intl. (Asia) Ltd. Clinical Research due to significant related party transactions (36.70%). The Tribunal upheld this rejection as it aligned with the established guidelines for comparability.

5. Identification of Functionally Non-Comparable Companies:
The Tribunal analyzed the functional profiles of the comparables identified by the TPO. It found that Celestial Labs Ltd., IDC (India) Ltd., and Mindtree Ltd. (Segmental) were not functionally comparable to the appellant due to their diversified operations and involvement in different industries. The Tribunal excluded these comparables from the benchmarking analysis.

6. Granting of ±5% Benefit:
The Tribunal directed the AO/TPO to re-examine the appellant's claim for the ±5% benefit under the proviso to Section 92C(2) of the Act, after excluding the non-comparable companies. This direction was given since the exclusion of the three comparables would bring the arithmetic mean of the remaining comparables within the ±5% range of the ALP.

7. Treatment of Software License Fees as Capital Expenditure:
The appellant claimed ?33,22,798 towards software license fees as revenue expenditure. The AO treated this as capital expenditure, allowing depreciation at 60%, resulting in an addition of ?13,29,119 to the total income. The Tribunal, after considering the nature of the expenditure and the purpose of the software licenses, held that the expenditure was for the efficient running of the existing computer systems and did not create any new asset. Therefore, it should be treated as revenue expenditure. The Tribunal directed the AO to allow the expenditure as revenue expenditure.

8. Addition to Total Income:
Consequently, the Tribunal directed the deletion of the addition of ?13,29,119 to the total income due to the reclassification of the software license fees as revenue expenditure.

Conclusion:
The appeal was partly allowed, with directions to the AO/TPO to re-examine the ALP after excluding the non-comparable companies and to treat the software license fees as revenue expenditure. The Tribunal's decision was based on a detailed analysis of the functional profiles of the comparables and the nature of the software license expenditure.