2013 (6) TMI 376 - AT - Income Tax

Transfer pricing adjustment - selection of comparable - determination of Arm s Length Price (ALP) - AO re-computed the deduction u/s 10A by holding that the communication expenses (i.e. the lease line charges broadband charges foreign travel expenses and insurance expenses) attributable to the delivery of computer software outside India should be reduced from the export turnover while computing the deduction under section 10A - Held that - As decided in CIT v Tata Elxsi Ltd. 2011 (8) TMI 782 - KARNATAKA HIGH COURT when the expenses are reduced from the export turnover while computing deduction under section 10A the same should also be reduced from the total turnover in order to maintain parity between the numerator and the denominator. In the light of the above judgment AO directed to reduce the said sum from the export turnover as well as from the total turnover while computing deduction under section 10A. Improper selection of comparable - Held that - The line of business of the assessee in this case and that of two case laws Trilogy E-Business Software India (P.) Ltd. s case 2013 (1) TMI 672 - ITAT BANGALORE & Mercedes Benz 2013 (6) TMI 56 - ITAT BANGALORE are similar namely development of software and the size/turnover was also similar to that of the assessee in the instant case. Moreover the assessment year 2007-08 was subject matter of consideration in the case of Trilogy E-Business Software India (P.) Ltd. (supra) and Mercedes Benz Research Development India (P.) Ltd. s case (supra) and the comparables selected by the TPO in those cases are identical to that of the instant case. The TPO had while selecting the above 26 comparables applied a lower turnover filter of Rs. 1 crore but preferred not to apply any upper turnover limit. The size of the comparable is an important factor in comparability. The ICAI TP guidance note has observed that the transaction entered into by a Rs. 1000 crores company cannot be compared with the transaction entered into by a Rs. 10 crores company and the two most obvious reasons are the size of the two companies and related economies of scale under which they operate. The TPO s range had resulted in selection of companies as comparable such as Infosys which was 277 times bigger than that of the assessee. The Bangalore Bench of the Tribunal in the case of Genisys Integrating Systems (India) (P.) Ltd. v. Dy. 2011 (8) TMI 952 - ITAT BANGALORE relying on Dun and Bradstreet s analysis had held that turnover range of Rs. 1 crore to 200 crores is appropriate. Thus in view of the above said reasoning the following 8 companies Flextronics Software Systems Limited iGate Global Solutions Limited Infosys Technologies Limited Mindtree Limited Persistent Systems Limited Persistent Systems Limited Sasken Communication Technologies Limited Tata Elxsi Limited, Wipro Limited will have to be eliminated from the list of comparable selected by the TPO. Inclusion of Lucid Software Ltd. as a comparable by the TPO - Held that - As identical objection has been raised against the inclusion of Lucid Software in case of Telcordia Technologies. Since the facts and the assessment year are identical following the order of the Tribunal in the case of Telcordia Technologies India (P.) Ltd. (2012 (6) TMI 388 - ITAT MUMBAI) direct the Assessing Officer/TPO not to include Lucid Software Limited as a comparable. After excluding from the TPO s list of comparables the companies having turnover exceeding Rs. 200 crores and five companies which are functional dissimilar to that of the assessee the following thirteen companies in TPO list are retained as comparables Datamatics Limited E Zest Solutions Limited Geometric Ltd. (seg) Helios & Matheson Information Technology Ltd IshirInfotech Ltd LGS Global Ltd (Lanco Global Solutions Ltd) Mediasoft Solutions Pvt. Ltd Megasoft Ltd (Seg) Quintegra Solutions Ltd R S Software (India) Ltd R Systems International Ltd (Seg) SIP Technologies & Exports Ltd Thirdware Solutions Ltd (Seg) Megasoft Ltd - In conformity with the findings of the earlier Bench in the case of Trilogy E-Business Software India (P.) Ltd. s (supra) we are of the considered view that the TPO was justified in selecting M/s. Megasoft Ltd as comparable. However the AO/TPO is directed to take segmental margins of 23.11% for comparability. It is ordered accordingly. Ishir InfoTech Limited - Since the facts and the assessment years are identical in conformity with the a order of the Tribunal in the case of Mercedes Benz Research Development India (P.) Ltd. (supra) Assessing Officer/TPO directed to re-examine whether Ishir Infotech Ltd. should be included in the list of comparables. AO/TPO is directed to work out the ALP of the assessee and if found that the differential in the margin of the assessee and the comparable is beyond 5% bandwidth recognized in proviso to section 92C (2) then adjustment is required to be made to the reported value of the assessee s transaction with its AE. It is ordered accordingly

Summary

Issues Involved:
1. Re-computation of deduction under section 10A of the Act.
2. Transfer Pricing adjustments.

Detailed Analysis:

I. 10A Deduction (Ground Nos. 2 & 3):
Issue: Whether communication expenses should be reduced from the export turnover while computing the deduction under section 10A of the Act.

Findings:
- The Assessing Officer re-computed the deduction under section 10A by reducing communication expenses from the export turnover.
- The assessee argued that these expenses should not be reduced or alternatively, if reduced from the export turnover, they should also be reduced from the total turnover.
- The Tribunal referred to the jurisdictional High Court ruling in CIT v Tata Elxsi Ltd., which mandates that expenses reduced from export turnover should also be reduced from total turnover to maintain parity.
- Conclusion: The Tribunal directed the Assessing Officer to reduce the communication expenses from both the export turnover and the total turnover while computing the deduction under section 10A. Thus, Ground No. 3 was allowed, and Ground No. 2 was not adjudicated as the alternative plea was accepted.

II. Transfer Pricing (Ground Nos. 5 to 13):
Issue: Determination of the Arm's Length Price (ALP) for international transactions with Associated Enterprises (AE).

Findings:
- The assessee used the Transaction Net Margin Method (TNMM) and selected 28 comparables, concluding that its transactions were within the Arm's Length range.
- The Transfer Pricing Officer (TPO) conducted a fresh analysis, selecting 26 comparables and making an adjustment of Rs. 2,76,72,297/-.
- The Tribunal considered various arguments and precedents to determine the appropriateness of the comparables selected by the TPO.

Key Points of Analysis:
1. Turnover Filter:
- The TPO applied a lower turnover filter of Rs. 1 crore but did not apply an upper limit.
- The Tribunal, referencing various cases, held that companies with a turnover exceeding Rs. 200 crores should be excluded.
- Conclusion: The following 8 companies were excluded due to high turnover: Flextronics Software Systems Ltd., iGate Global Solutions Ltd., Infosys Technologies Ltd., Mindtree Ltd., Persistent Systems Ltd., Sasken Communication Technologies Ltd., Tata Elxsi Ltd., and Wipro Ltd.

2. Functional Dissimilarity:
- Certain companies were excluded for being functionally dissimilar based on precedents:
- Accel Transmatic Ltd. (Seg): Excluded as it was not comparable for software development services.
- Avani Cimcon Technologies Ltd.: Excluded due to functional differences.
- Celestial Labs. Ltd.: Excluded as it was primarily involved in clinical research and bio-products.
- KALS Information Systems Ltd. (Seg): Excluded due to reliance on non-public information and functional differences.
- Lucid Software Ltd.: Excluded due to involvement in software product development.
- Conclusion: The above companies were excluded from the list of comparables.

3. Megasoft Limited:
- The Tribunal accepted the segmental margin of 23.11% for comparability instead of the entity-level margin.
- Conclusion: The TPO was directed to use the segmental margin for Megasoft Ltd.

4. Ishir Infotech Limited:
- The issue was restored to the TPO to re-examine whether professional fees paid were for outsourced work, affecting the employee cost filter.
- Conclusion: The TPO was directed to re-examine the inclusion of Ishir Infotech Ltd.

Final Computation:
- After excluding the inappropriate comparables, the Tribunal retained 13 companies as comparables.
- The TPO was directed to re-compute the ALP with the retained comparables and check if the differential margin falls within the permissible range of +/-5%.

Conclusion:
- The appeal was partly allowed, with specific directions for re-computation under section 10A and re-evaluation of the transfer pricing adjustments based on the revised list of comparables.