2016 (2) TMI 1123 - AT - Income Tax

Computation of the deduction under Section 10-A - Exclusion of expenditure incurred in foreign exchange from export turnover as well as from total turnover - Held that - As held by the Hon ble High Court in Tata Elxsi Ltd (2011 (8) TMI 782 - KARNATAKA HIGH COURT) expenses excluded from export turnover had to be excluded from the total turnover also while working out the eligible deduction. Exclusion of certain comparables by the DRP for the purpose of determining the arm s length price ALP - TPA - Held that - The assessee is a company and engaged in the business of developing software solution services as well as rendering sales and support services for its products. The assessee provides two category of services; software development and sales & marketing support services. The assessee has entered into separate agreements for provision of software development as well as sales & marketing services to its group EFI. Companies functinally dissimilar with that of assessee need to be deselected from final list of comparables.

Issues Involved:

1. Exclusion of expenditure incurred in foreign exchange from export turnover and total turnover.
2. Exclusion of certain comparables for determining the arm's length price (ALP) in software development services.
3. Treatment of foreign exchange loss/gain as operating revenue.
4. Determination of ALP in marketing and sales support services segment.
5. Inclusion/exclusion of specific companies as comparables in different segments.

Detailed Analysis:

1. Exclusion of Expenditure Incurred in Foreign Exchange from Export Turnover and Total Turnover:

The Revenue contested the exclusion of reimbursement of specific expenditure from both export turnover and total turnover for the purpose of computing deduction under Section 10A. The Dispute Resolution Panel (DRP) directed the Assessing Officer (AO) to exclude such expenditure from both turnovers, relying on the Karnataka High Court's decision in Tata Elxsi Ltd. The Tribunal upheld the DRP's direction, emphasizing that for uniformity and to avoid anomalies, the same exclusions applied to export turnover must also apply to total turnover.

2. Exclusion of Certain Comparables for Determining the ALP in Software Development Services:

The Revenue challenged the DRP's exclusion of several comparables. The Tribunal analyzed each disputed comparable:

- ICRA Techno Analytics Ltd.: Excluded due to its diversified activities beyond software development services, including software consultancy, engineering services, and web development without segmental information.
- Infosys Ltd.: Excluded because of its significant brand value, intangible assets, and diverse activities, making it incomparable to the assessee.
- KALS Information Systems Ltd.: Excluded due to its involvement in software products and training services, evidenced by inventories in its balance sheet.
- Persistent Systems Ltd.: Excluded due to its diversified revenue streams, including product licensing, royalties, and maintenance contracts, without segmental data.
- Sasken Communication Technologies Ltd.: Excluded due to revenue from software services, products, and other services without segmental margins.
- Tata Elxsi Ltd.: Excluded due to its engagement in diverse activities within its software development segment, such as product design and engineering services.

3. Treatment of Foreign Exchange Loss/Gain as Operating Revenue:

The DRP directed the AO to treat foreign exchange fluctuation as operating in nature if it arises from the realization of sales or payment to suppliers. The Tribunal upheld this, stating that foreign exchange gain/loss related to trading activities should be considered operating revenue. The AO/TPO was directed to verify the source of foreign exchange gain/loss for both the assessee and comparables.

4. Determination of ALP in Marketing and Sales Support Services Segment:

The DRP excluded certain comparables selected by the TPO for marketing and sales support services:

- HCCA Business Services Pvt. Ltd.: Excluded due to its primary engagement in payroll processing services, which is functionally different from the assessee's services.
- Killick Agencies & Marketing Ltd.: Excluded as its commission/service charges income constituted less than 75% of its operating revenue, failing the TPO's filter, and its business activities were functionally dissimilar to the assessee's.

5. Inclusion/Exclusion of Specific Companies as Comparables in Different Segments:

The Tribunal addressed objections raised by the assessee in its cross-objection:

- Asian Business Exhibition & Conference Ltd.: Excluded as its primary business of organizing exhibitions and events was functionally different from the assessee's sales and marketing support services.
- R.S. Software (India) Ltd.: Excluded due to its predominant onsite software development activities, evidenced by significant foreign branch expenditure.
- Persistent Systems & Solutions Ltd.: Excluded due to lack of segmental data for its software services and products.
- Larsen & Toubro Infotech Ltd.: Directed the AO/TPO to apply a 15% related party transaction (RPT) filter and verify revenue details to determine comparability.
- Mindtree Ltd.: Retained as comparable despite objections regarding turnover filter and bad debts, as the bad debts were not considered operating in nature for the year under consideration.

The Tribunal directed the AO/TPO to recompute the ALP in both software development and marketing support services segments, considering the exclusions and parameters discussed. The appeal of the Revenue and the cross-objection of the assessee were partly allowed.

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