2011 (5) TMI 499 - AT - Income Tax

Transfer pricing adjustment - Arm s length price - Software development services - Held that - Since the OP/TC of the appellant at 12.49% is within the safe harbour range of ( /-)5% as per the proviso to section 92C(2) of OP/TC margin of 3 comparable companies at 13.01%, no adjustment is warranted on account of difference in arm s length price of the international transaction - Decided in favour of assessee. Expenditure on advertisement and sale promotion and recruitment and training expenses disallowed - AO is of the opinion that only 25% of the expenditure should be allowed during the year and the rest has to be added to the income of the assessee - Held that - As it is not the case that the expenses are bogus and not incurred & also not the case that the entire expenses falls under the realm of capital expenses find ourselves in agreement with the contention of assessee that there is no concept of deferred revenue expenditure under the IT law - The expenditure of account of recruitment and training expenses and advertisement and sales promotion expenses cannot be said to be capital expenditure - Thus AO s action in this regard is not sustainable - Moreover,note that similar disallowance were deleted by the Ld. Commissioner of Income-tax (Appeals) in the assessment year 2004-05 against which the department did not file appeal before the Tribunal - Decided in favour of assessee.

Issues Involved:
1. Addition of Rs. 14,79,00,000 on account of alleged difference in arm's length price of international transactions.
2. Disallowance of Rs. 1,18,31,549 out of expenditure on advertisement, sales promotion, and recruitment and training expenses.

Issue-Wise Detailed Analysis:

1. Addition of Rs. 14,79,00,000 on Account of Alleged Difference in Arm's Length Price:

The assessee, a subsidiary of M/s. Sapient Corporation, USA, engaged in customized software development services, determined the arm's length price (ALP) of its international transactions using the Transactional Net Margin Method (TNMM). The assessee benchmarked its transactions with 10 comparable companies, resulting in an average operating profit ratio (OP/TC) of 9.31%. The assessee's operating profit margin was 12.49%, which was higher than the average, indicating that the transactions were at arm's length.

The Transfer Pricing Officer (TPO) required current year data for comparable companies, resulting in a revised OP/TC ratio of 12.05%. The TPO rejected five comparable companies due to various reasons, such as decreasing profitability trends and negative net worth, and benchmarked the assessee's margin against four high-profit companies, resulting in an arithmetic mean of 22.19%. Consequently, the TPO computed an adjustment of Rs. 14,79,00,000.

The assessee contended that Zenith Infotech, with an abnormal profit margin of 49.73%, should be excluded as it did not satisfy the TPO's additional filters and was predominantly a software product company, unlike the assessee, which provided software development services. The assessee cited several judicial precedents supporting the exclusion of super-profit companies from comparables.

The Tribunal agreed with the assessee, noting that the TPO had excluded loss-making companies but included a super-profit company, Zenith Infotech, which was inconsistent. The Tribunal found that the software product company showed higher margins due to different business models. Excluding Zenith Infotech, the revised arithmetic mean of the remaining three companies was 13.01%, and the assessee's margin of 12.49% fell within the safe harbor range of (+/-) 5%. Thus, no adjustment was warranted, and the addition was deleted.

2. Disallowance of Rs. 1,18,31,549 Out of Expenditure on Advertisement, Sales Promotion, and Recruitment and Training Expenses:

The Assessing Officer (AO) disallowed Rs. 1,18,31,549 out of the total expenditure of Rs. 1,57,75,411, contending that these expenses provided enduring benefits and should be deferred. The assessee argued that there is no concept of deferred revenue expenditure under the Income-tax Act and cited case laws supporting the full deduction of such expenses in the year incurred.

The Tribunal found that the AO's disallowance was unsustainable as there is no provision for deferred revenue expenditure under the IT law. The expenses on recruitment, training, advertisement, and sales promotion were revenue in nature and not capital expenditures. The Tribunal also noted that similar disallowances were deleted in the previous assessment year, and the department did not appeal against the deletion. Consequently, the disallowance was deleted.

Conclusion:

The appeal filed by the assessee was allowed, with the Tribunal deleting the addition of Rs. 14,79,00,000 related to the arm's length price adjustment and the disallowance of Rs. 1,18,31,549 related to advertisement, sales promotion, and recruitment and training expenses. The order was pronounced in the open court on 6-5-2011.

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