2017 (1) TMI 1556 - AT - Income Tax

Eligibility to deduction claimed u/s 10B - alternate claim of section 10A deduction - Held that - The issue which arises before us is identical to the issue before the Tribunal in assessment year 2009-10 2015 (3) TMI 151 - ITAT PUNE . The year under appeal before us is assessment year 2010-11 and following the same parity of reasoning, we hold that the assessee is not entitled to the claim of deduction under section 10B of the Act. However, eligibility of deduction under section 10A of the Act in the hands of assessee merits to be verified. Accordingly, we remit this issue back to the file of Assessing Officer to verify the claim of assessee and pass order in accordance with law and also following the directions of Tribunal in earlier years. Adjustment made on account of transfer pricing provisions - comparable selection criteria - Held that - Companies functionally not comparable to the assessee which is rendering software services to its holding company need to be deselected from final list. Thirdware Solutions Ltd. and ALS Information System Ltd. to be excluded from final list.

Issues Involved:
1. Disallowance of deduction under section 10B of the Income-tax Act, 1961.
2. Rejection of alternate claim of deduction under section 10A of the Act.
3. Adjustment of arm's length price and transfer pricing issues.
4. Selection and rejection of comparables in the transfer pricing study.
5. Application of Safe Harbor Rules.
6. Inclusion of high/super profit-making companies in the final set of comparables.
7. Exclusion of loss-making companies.
8. Risk adjustment to Operating Profit/Operating Cost of selected comparables.
9. Consistency in the selection of comparables across assessment years.
10. Opportunity for verification of the search strategy and comparables.
11. Application of Section 92C(3) of the Act concerning transfer pricing documentation.
12. Use of multiple-year data and contemporaneous data.
13. Lack of motive for tax evasion.
14. Levy of interest under sections 234B and 234C of the Act.
15. Initiation of penalty proceedings under section 271(1)(c) of the Act.

Detailed Analysis:

1. Disallowance of Deduction under Section 10B:
The CIT(A) upheld the disallowance of the deduction under section 10B of the Act on the grounds that the approval from the Software Technology Park of India (STPI) was not ratified by the Board of Approval constituted under section 14 of the Industrial Development Regulation Act. The Tribunal found that the assessee was not entitled to the claim of deduction under section 10B of the Act, as the necessary approval was not received from the Development Commissioner.

2. Rejection of Alternate Claim of Deduction under Section 10A:
The CIT(A) also denied the alternate claim of deduction under section 10A of the Act, stating that the appellant did not meet the fundamental condition of being located in a 'free trade zone.' The Tribunal, however, noted that the assessee had filed the report of the accountant in Form 56F during the assessment proceedings and made an alternate claim under section 10A of the Act. The Tribunal held that the assessee would be entitled to the benefit of deduction under section 10A, and remitted the issue back to the Assessing Officer to verify the fulfillment of conditions provided in section 10A.

3. Adjustment of Arm's Length Price and Transfer Pricing Issues:
The Assessing Officer made an adjustment of ?2,12,11,149 to the income returned by the appellant by re-computing the arm's length price of the international transactions. The Tribunal noted that the assessee had applied the Transactional Net Margin Method (TNMM) and adopted the operating profit to total cost as the Profit Level Indicator (PLI). The Assessing Officer, however, found defects in benchmarking and worked out the PLI margins of comparable companies at 33.92% against the assessee's 11.27%.

4. Selection and Rejection of Comparables:
The Tribunal addressed the selection of KALS Information System Ltd. and Thirdware Solution Ltd. as comparables. It was noted that both companies were functionally different as they were involved in product development and sales, making them not comparable to the assessee. The Tribunal directed the Assessing Officer to exclude these companies from the final set of comparables and re-compute the margins.

5. Application of Safe Harbor Rules:
The CIT(A) directed the Assessing Officer to follow the provisions of the Safe Harbor Rules for calculating the correct margin of Thinksoft Global Services Limited.

6. Inclusion of High/Super Profit-Making Companies:
The Tribunal noted that Thirdware Solution Ltd. was a super profit-earning company and engaged in multiple activities, including trading of software licenses and training implementation activities. The Tribunal held that such companies should not be included in the list of comparables.

7. Exclusion of Loss-Making Companies:
The Tribunal did not specifically address this issue in detail, but it was implied that the selection of comparables should be consistent and based on functional similarity.

8. Risk Adjustment:
The Tribunal did not specifically address this issue, but it emphasized the need for a consistent approach in the selection of comparables.

9. Consistency in Selection of Comparables:
The Tribunal noted that the Assessing Officer did not follow a consistent approach in selecting comparables across different assessment years, which was a point of contention for the assessee.

10. Opportunity for Verification:
The Tribunal noted that the Assessing Officer did not share the search strategy, accept/reject matrix, or source of additional comparables with the assessee, even after requests were made during submissions and hearings.

11. Application of Section 92C(3):
The Tribunal did not specifically address this issue in detail, but it was implied that the Assessing Officer did not satisfy the requirements of Section 92C(3) of the Act while rejecting the transfer pricing documentation maintained by the assessee.

12. Use of Multiple-Year Data:
The Tribunal did not specifically address this issue in detail, but it was implied that the use of relevant financial year data should be consistent and justified.

13. Lack of Motive for Tax Evasion:
The Tribunal did not specifically address this issue, but it was noted that the assessee had no motive to shift profits as it was entitled to benefits under section 10B of the Act.

14. Levy of Interest under Sections 234B and 234C:
The Tribunal noted that the grounds of appeal against the levy of interest under sections 234B and 234C of the Act were consequential in nature.

15. Initiation of Penalty Proceedings:
The Tribunal noted that the ground of appeal against the initiation of penalty proceedings under section 271(1)(c) of the Act was premature.

Conclusion:
The Tribunal partly allowed the appeal of the assessee, remitting the issue of eligibility for deduction under section 10A back to the Assessing Officer for verification and excluding certain comparables from the final set for transfer pricing adjustments. The Tribunal emphasized the need for consistency and functional similarity in the selection of comparables and directed the Assessing Officer to re-compute the margins accordingly.

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