2016 (8) TMI 1312 - AT - Income Tax

TPA - comparable selection criteria - Held that - The assessee company is engaged in rendering services to the AE relating to designing of integrated circuits and the testing of integrated circuits along with customer support. It is also noted by the TPO that the international transactions are mainly for software services apart from re-imbursement of expenses, thus companies functionally dissimilar with that of assessee need to be deselected from final list of comparable.

Issues Involved:
1. Incorrect interpretation of law by AO and DRP.
2. Assessment of total income.
3. Reduction of telecommunication expenses from export turnover.
4. Reduction of travel expenses from export turnover.
5. Consideration of total turnover for computing deduction under Section 10A.
6. Transfer pricing adjustments for software development services and IT-enabled services.
7. Rejection of economic analysis by the appellant.
8. Intention to shift profit base out of India.
9. Use of financial year 2006-07 data for arm's length price determination.
10. Rejection of certain comparables by AO/TPO.
11. Use of information not available in public domain.
12. Non-consideration of foreign exchange fluctuation gain/loss.
13. Non-adjustment for differences in risk profile.
14. Non-application of +/- 5 percent benefit under Section 92C.
15. Rejection of comparables based on 'onsite revenues' criterion.
16. Rejection of comparables based on 'employee cost' criterion.
17. Acceptance/rejection of companies based on unreasonable criteria.
18. Wrong computation of operating margins of comparables.
19. Acceptance/rejection of companies for IT-enabled services based on unreasonable criteria.
20. Levy of interest under Sections 234B and 234C.
21. Initiation of penalty proceedings under Section 271(1)(c).

Detailed Analysis:

1. Incorrect Interpretation of Law by AO and DRP:
The appellant contended that the order of the AO and the directions of the DRP were based on an incorrect interpretation of law, making them "bad in law." This issue was foundational to the appeal, asserting that the legal framework applied was flawed.

2. Assessment of Total Income:
The appellant argued that the AO erred in assessing the total income at ?5,80,49,828 as against the returned income of ?2,32,78,452. This discrepancy arose from various adjustments and disallowances made by the AO.

3. Reduction of Telecommunication Expenses from Export Turnover:
The AO reduced telecommunication expenses (leased line charges) amounting to ?35,41,839 from the export turnover while computing the deduction under Section 10A. The appellant contended this reduction was erroneous.

4. Reduction of Travel Expenses from Export Turnover:
Similarly, the AO reduced travel expenses amounting to ?1,33,99,313 incurred in foreign currency from the export turnover, considering them as technical services rendered outside India. The appellant disputed this reduction.

5. Consideration of Total Turnover for Computing Deduction under Section 10A:
The appellant argued that if telecommunication and travel expenses were to be reduced from export turnover, an equal amount should also be reduced from total turnover for computing the deduction under Section 10A. This alternative plea was not considered by the AO.

6. Transfer Pricing Adjustments for Software Development Services and IT-enabled Services:
The AO/TPO made significant additions to the appellant's income on account of adjustments in the arm's length price of software development services and IT-enabled services transactions with associated enterprises. The appellant contested these adjustments.

7. Rejection of Economic Analysis by the Appellant:
The AO/TPO disregarded the economic analysis undertaken by the appellant without proper justification and conducted a fresh economic analysis, concluding that the appellant's international transactions were not at arm's length.

8. Intention to Shift Profit Base Out of India:
The appellant argued that since it was availing tax holiday under Section 10A, there was no intention to shift the profit base out of India, which is a fundamental concern of transfer pricing provisions.

9. Use of Financial Year 2006-07 Data for Arm's Length Price Determination:
The AO/TPO used only financial year 2006-07 data to determine the arm's length price, which was not available to the appellant at the time of complying with transfer pricing documentation requirements.

10. Rejection of Certain Comparables by AO/TPO:
The AO/TPO rejected certain comparables identified by the appellant using various criteria such as consolidated results, turnover less than ?1 crore, diminishing revenue trend, and different accounting years. The appellant contested these rejections.

11. Use of Information Not Available in Public Domain:
The AO/TPO obtained information not available in the public domain by exercising powers under Section 133(6) and relied on this information for comparability analysis, which the appellant argued was improper.

12. Non-consideration of Foreign Exchange Fluctuation Gain/Loss:
The AO/TPO did not consider foreign exchange fluctuation gain (loss) as part of the operating income while computing the operating margin, which the appellant argued was incorrect.

13. Non-adjustment for Differences in Risk Profile:
The AO/TPO did not make suitable adjustments for differences in the risk profile of the appellant vis-a-vis the comparables while conducting the comparability analysis.

14. Non-application of +/- 5 Percent Benefit Under Section 92C:
The AO/TPO computed the arm's length price without giving the benefit of +/- 5 percent under the proviso to Section 92C, which the appellant argued was a legal entitlement.

15. Rejection of Comparables Based on 'Onsite Revenues' Criterion:
The AO/TPO rejected certain comparables identified by the appellant using 'onsite revenues greater than 75% of the export revenues' as a comparability criterion, which the appellant argued was unreasonable.

16. Rejection of Comparables Based on 'Employee Cost' Criterion:
The AO/TPO also rejected comparables using 'employee cost greater than 25% of the total revenues' as a comparability criterion, which the appellant contested.

17. Acceptance/Rejection of Companies Based on Unreasonable Criteria:
The appellant argued that the AO/TPO accepted or rejected certain companies based on unreasonable comparability criteria, affecting the arm's length price determination.

18. Wrong Computation of Operating Margins of Comparables:
The AO/TPO wrongly computed the operating margins of some of the comparable companies, which the appellant argued led to incorrect transfer pricing adjustments.

19. Acceptance/Rejection of Companies for IT-enabled Services Based on Unreasonable Criteria:
For the IT-enabled services segment, the appellant argued that the AO/TPO accepted or rejected certain companies based on unreasonable comparability criteria.

20. Levy of Interest Under Sections 234B and 234C:
The AO levied interest of ?68,88,846 and ?1,75,014 under Sections 234B and 234C respectively, which the appellant contested.

21. Initiation of Penalty Proceedings Under Section 271(1)(c):
The AO initiated penalty proceedings under Section 271(1)(c), which the appellant argued was unwarranted.

Conclusion:
The Tribunal considered the rival submissions and various precedents, directing the AO/TPO to exclude certain comparables and reconsider others based on functional dissimilarity and other criteria. The Tribunal also directed the AO/TPO to rework the segmental results for some comparables and to pass necessary orders after providing an opportunity of being heard to the appellant. The appeal was partly allowed for statistical purposes.

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