2011 (8) TMI 952 - AT - Income Tax

Transfer Pricing adjustments - Arms length price (ALP) - u/s 92CA - software development and IT enabled services - selection of comparable - products are generally sold on license basis wherein the right to use the software is transferred without giving the source code. - arithmetic mean of these comparables - held that - TPO himself has rejected the companies which are making losses as comparables. This shows that there is a limit for the lower end for identifying the comparables. In such a situation, we are unable to understand as to why there should not be an upper limit also. What should be upper limit is another factor to be considered. Size matters in business - A big company would be in a position to bargain the price and also attract more customers. It would also have a broad base of skilled employees who are able to give better output. A small company may not have these benefits and therefore, the turnover also would come down reducing profit margin. Thus, as held by the various benches of the Tribunal, when companies which are loss making are excluded from comparables, then the super profit making companies should also be excluded. - companies having a turnover of ₹ 1.00 core to 200 crores have to be taken as a particular range and the assessee being in that range having turnover of 8.15 crores, the companies which also have turnover of 1.00 to 200.00 crores only should be taken into consideration for the purpose of making TP study. What is the data to be considered by the TPO at the time of determining ALP? - Whether the assessee should be given an opportunity to rebut the material sought to be used by the TPO? - held that - it is clear that the Act has not provided for any cut off date upto which only the information available in public domain has to be taken into consideration by the TPO, while making the TP adjustments and arriving at arm s length price. The assessee as well as the revenue are both bound by the Act and the Rules there under and therefore, as provided under the Act and Rules they are supposed to be taking into consideration, the contemporaneous data relevant to the previous year in which the transaction has taken place. When he is making the search for a relevant comparable, the TPO can issue notices to the parties whom he considers as relevant to gather requisite information and on being satisfied with regard to relevancy of the material which can be used against the assessee only then the assessee has to be given an opportunity of presenting its objections. Thus, the TPO need not inform the assessee about the process used by him for issuing the notices u/s 133(6) nor is he under any obligation to furnish the entire information to the assessee. All the comparables have to be compared on similar standards and the assessee cannot be put in a dis-advantageous position, when in the case of other companies adjustments for under utilization of manpower is given. The assessee should also be given adjustment for under utilization of its infrastructure. The AO shall consider this fact also while determining the ALP and make the TP adjustments.

Summary

Issues Involved:
1. Natural Justice and Procedure
2. Transfer Pricing Adjustments and Comparables
3. Data and Information Used by TPO
4. ALP Adjustments for ITES Segment
5. Low Capacity Utilization Adjustments

Detailed Analysis:

1. Natural Justice and Procedure:
The assessee raised concerns about the principles of natural justice and procedural aspects followed by the AO in making a reference to the TPO and the order passed by the DRP. However, these grounds were not pressed by the assessee and were accordingly rejected.

2. Transfer Pricing Adjustments and Comparables:
The assessee, engaged in software development and IT-enabled services, challenged the TPO's rejection of its selected comparables and the adoption of new comparables. The TPO had applied additional filters and selected 20 comparables, resulting in a transfer pricing adjustment of Rs. 2,20,12,927/- for the software segment and Rs. 66,38,48/- for the ITES segment. The assessee argued that the transfer pricing adjustments should be restricted to transactions with AE only and that the operating costs and revenues referable to AE transactions should be considered. The Tribunal agreed with the assessee, directing the AO to restrict the adjustments to AE transactions only.

3. Data and Information Used by TPO:
The assessee contended that the TPO's use of data obtained through notices u/s 133(6) was not transparent and lacked fairness. The Tribunal held that the TPO is authorized to gather information and issue notices to relevant parties under sec.92CA and sec.133(6). However, the assessee must be given an opportunity to rebut any material used against it. The Tribunal found that the TPO had provided all information to the assessee in the form of a CD and allowed the assessee to present its objections. The Tribunal also directed that the assessee should be given an opportunity to cross-examine parties whose replies are used against it.

4. ALP Adjustments for ITES Segment:
The Tribunal directed the TPO to consider the assessee's objections and compute the ALP for the ITES segment, following the same directions given for the software development service segment. This included considering only the operating revenue and costs of AE transactions, applying a turnover filter of Rs. 1 crore to 200 crores, and providing the assessee an opportunity to cross-examine relevant parties.

5. Low Capacity Utilization Adjustments:
The assessee argued for adjustments due to under-utilization of infrastructure, which was rejected by the TPO. The Tribunal agreed with the assessee, noting that similar adjustments for under-utilization of manpower were allowed in other cases. The Tribunal directed the AO to consider the adjustment for under-utilization of infrastructure while determining the ALP.

Conclusion:
The Tribunal partly allowed the appeal for statistical purposes, directing the TPO to:
- Consider only the operating revenue and costs of AE transactions.
- Apply a turnover filter of Rs. 1 crore to 200 crores.
- Provide all relevant information to the assessee.
- Allow the assessee to cross-examine parties whose replies are used against it.
- Consider the assessee's objections to additional comparables.
- Grant a standard deduction of 5% under the proviso to sec.92C(2).
- Consider adjustments for under-utilization of infrastructure in the ITES segment.