2010 (8) TMI 676 - AT - Income Tax

Arms Length Price (ALP) - Reference to TPO - TNMM method - 100% EOU - Deduction u/s 10A - The law provided that whenever a business is carried on between a resident and a non-resident and it appears to the Income-tax Officer that, owing close connection between them, the course of business is so arranged that the business transaction between them produce to the resident either no profits or less than the ordinary profits, the Income-tax Officer shall determine the amount of profits, which reasonably be deemed to have been derived therefrom and adopt such amount in the total income of the resident - it is necessary to understand that even without a specific provision like section 92, it is always possible for the assessing authority to examine every vital and relevant aspect of international transactions between related parties in the course of assessment proceedings - the operating margin of the assessee-company at 8.80 per cent - The arithmetic mean will be worked out on the basis of the combined list of both TPO/Assessing Officer and the assessee-company, comprising 12 comparables - The assessing authority will further find out the operating profits at assessee s rate of 13.80 per cent and the operating profits at the arithmetic mean rate of 20.57 per cent on the basis of the revised revenue and cost computed in paragraph above - This amount will be corresponding to the differential operating margin of 6.77 per cent Regarding disallowance of Rs. 1.05 crores - whether the liability was created for the purpose of carrying on the business in the normal course or for the purpose of establishing the business itself - While dealing with the transfer pricing issue, particularly while re-computing the profit margin attributable to assessee s business, we have held that the payment is an extraordinary item and has to be excluded from the expenditure side to work out the operating profit of the assessee - It is a different matter that the assessee has not acquired any tangible asset or any enduring benefit - Decided against the assessee Regarding lease line/high speed link charges - Since the total turnover is only the aggregate of the domestic and export turnover, it naturally follows that items of expense incurred in foreign exchange and to the extent attributable to the delivery of computer software out of India which have been excluded from export turnover cannot be included in the total turnover - in the case of ITO v. SAK Soft Ltd. 2009 313 (AT) 3536 - Held that the scheme of sections 80HHC and 80HHE has to be considered analogous to the scheme of section 10B and, therefore, the adjustment made in the export turnover should be reflected in the total turnover as well - Decided in the favour of assessee

Issues Involved:
1. Transfer Pricing Adjustment
2. Disallowance of Compensation Payment
3. Reduction of Lease Line Charges from Total Turnover for Section 10A Deduction

Detailed Analysis:

1. Transfer Pricing Adjustment:
Background:
The assessee, an Export Oriented Unit (EOU) providing software development services to its German parent company, SAP AG, reported a loss. The Transfer Pricing Officer (TPO) revised the operating profit ratio to 5.43% and adopted the Transactional Net Margin Method (TNMM) to determine the Arm's Length Price (ALP), resulting in an ALP adjustment of Rs. 11,42,86,466.

Contentions and Findings:
- Reference to TPO: The assessee argued that the reference to TPO was made without an opportunity to be heard. The Tribunal held that the TPO's reference is part of the assessment procedure and does not violate natural justice as the assessee is heard during the TPO's analysis.
- Selection of Most Appropriate Method (MAM): The assessee contended that the TPO should not switch methods. The Tribunal clarified that the TPO can select the most appropriate method after evaluating all methods.
- Operating Margin Computation: The Tribunal accepted the inclusion of foreign exchange fluctuation gains and exclusion of compensation payment from operating costs, revising the assessee's operating margin to 8.80%.
- Normalization of Super Profits: The Tribunal excluded companies with supernormal profits like Hinduja TMT Ltd. and Aftek Infosys Ltd. from the comparables list.
- 5% Marginal Relief: The Tribunal held that the assessee is entitled to a 5% standard deduction under the old proviso to section 92C(2).

Conclusion:
The Tribunal revised the arithmetic mean of the comparables to 20.57% and adjusted the assessee's operating margin to 13.80% after the 5% standard deduction. The revised differential margin was 6.77%, and the assessing authority was directed to recompute the ALP adjustment accordingly.

2. Disallowance of Compensation Payment:
Background:
The assessee paid Rs. 1.05 crores as compensation for terminating a property purchase agreement and claimed it as a deductible expense.

Contentions and Findings:
- Assessee's Argument: The payment was for discharging a contractual liability and should be treated as revenue expenditure.
- Revenue's Argument: The payment was for establishing capital infrastructure and is capital in nature.
- Tribunal's Decision: The Tribunal held that the payment was for discharging a capital liability and not a revenue liability, thus confirming the disallowance by the lower authorities.

Conclusion:
The Tribunal upheld the disallowance of Rs. 1.05 crores as a capital expenditure.

3. Reduction of Lease Line Charges from Total Turnover for Section 10A Deduction:
Background:
The Assessing Officer reduced the export turnover by Rs. 35,83,000 for lease line charges but did not make a corresponding reduction in the total turnover.

Contentions and Findings:
- Assessee's Argument: The total turnover should be adjusted in the same manner as the export turnover.
- Tribunal's Decision: The Tribunal referred to the ITAT Chennai Special Bench decision in SAK Soft Ltd., holding that adjustments made in the export turnover should reflect in the total turnover.

Conclusion:
The Tribunal upheld the CIT(A)'s direction to exclude lease line charges from the total turnover, dismissing the revenue's appeal.

Summary:
The Tribunal's judgment addressed three main issues: transfer pricing adjustments, the nature of compensation payment, and the treatment of lease line charges for Section 10A deduction. The Tribunal provided a detailed analysis, partially allowing the assessee's appeal on transfer pricing and dismissing the revenue's appeal on lease line charges, while upholding the disallowance of compensation payment as a capital expenditure.

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