2016 (6) TMI 1293 - AT - Income Tax

TPA - comparable selection - Held that - Assessee has provided software development services to its Associated Enterprises thus companies functionality dissimilar with that of assessee need to be deselected from final list. We direct the TPO to consider the risk adjustment of the margins of comparables for bringing them on par with the assessee. Nature of expenditure - web site creation expenses - revenue or capital - Held that - Without going into the controversy of allowable revenue expenditure we are of the view that even if this expenditure is considered as capital in nature the assessee is entitled for depreciation on the entire expenditure incurred once the work of web site creation is completed. The A.O has already allowed the depreciation for the asst. year 2010-11. Therefore we uphold the orders of the authorities below treating the said expenditure as capital in nature however the assessee may claim depreciation on the entire amount from the year in which the work is completed and the asset has come into existence. Exclusion of freight charges telecommunication charges insurance charges travelling and financial charges from the export turnover as well as total turnover while computing the deduction u/s. 10A - Held that - Hon ble Karnataka High Court in the case of CIT v M/s Tata Elxsi Ltd. & Others (2011 (8) TMI 782 - KARNATAKA HIGH COURT) had held that while computing the exemption u/s 10A if the export turnover in the numerator is to be arrived at after excluding certain expenses the same should also be excluded from the total turnover in the denominator.

Issues Involved:
1. Transfer Pricing Adjustments
2. Selection of Comparable Companies
3. Computation of Operating Margin
4. Exclusion of Specific Expenses from Operating Cost
5. Risk Adjustment
6. Treatment of Website Creation Expenses
7. Computation of Deduction under Section 10A

Detailed Analysis:

1. Transfer Pricing Adjustments:
The primary issue revolves around the determination of the Arm’s Length Price (ALP) for international transactions involving software development services provided by the assessee to its Associated Enterprises (AEs). The Transfer Pricing Officer (TPO) did not accept the international transactions in the software development services segment at arm’s length and proposed an adjustment of Rs. 8,34,25,710 under Section 92CA.

2. Selection of Comparable Companies:
The assessee selected 21 comparable companies, out of which the TPO accepted 6 and added 14 more, arriving at an arithmetic mean of 26.35%, adjusted to 23.5% after working capital adjustments. The Commissioner of Income Tax (Appeals) [CIT (A)] rejected 9 companies from the TPO’s list and included one additional company, directing the TPO/A.O to retain 12 comparable companies. The Tribunal further directed the exclusion of 12 companies from the TPO's set based on functional dissimilarity, following the precedent set in the case of Kodiak Network (India) Pvt. Ltd.

3. Computation of Operating Margin:
The assessee contested the TPO's computation of the operating margin, arguing that Fringe Benefit Tax (FBT) should be excluded from the operating cost. The Tribunal directed the TPO to exclude FBT from the operating cost, aligning with the decision in the assessee's case for the assessment year 2007-08.

4. Exclusion of Specific Expenses from Operating Cost:
The Tribunal upheld the exclusion of FBT from the operating cost for computing the arm’s length price, emphasizing consistency with the treatment of comparables.

5. Risk Adjustment:
The assessee sought risk adjustment as a captive service provider. The Tribunal directed the TPO to consider the risk adjustment of the margins of comparables, following precedents from similar cases like Kodiak Network (India) Pvt. Ltd. and 3DPLM Software Solutions Ltd.

6. Treatment of Website Creation Expenses:
The Tribunal upheld the CIT (A)'s treatment of website creation expenses as capital in nature but allowed depreciation on the entire expenditure from the year the asset was completed. This decision was consistent with the treatment in the assessment year 2010-11.

7. Computation of Deduction under Section 10A:
The Tribunal addressed the exclusion of freight charges, telecommunication charges, insurance charges, and traveling expenses from both export turnover and total turnover for computing the deduction under Section 10A. The Tribunal upheld the CIT (A)'s decision, aligning with the Karnataka High Court's ruling in the case of CIT v. Tata Elxsi Ltd. and the Bombay High Court's decision in CIT v. Gem Plus Jewellery India Ltd., ensuring parity between the numerator and denominator in the formula for calculating the deduction.

Conclusion:
The Tribunal directed the TPO to recompute the ALP after excluding 12 comparable companies, considering the correct operating margin excluding FBT, and applying risk adjustment. The Tribunal also upheld the exclusion of specified expenses from both export and total turnover for Section 10A deduction computation. The appeals of both the assessee and the revenue were partly allowed, with specific directions for re-examination and recalculations.

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