2014 (4) TMI 285 - AT - Income Tax

Transfer pricing adjustment Provision of software development services - Determination of ALP - Non application of CUP/TNMM to internal uncontrolled transactions - Bad debts, reimbursements to be included in the operating cost or not Held that - The segmental details have been furnished by the assessee, the TPO should have considered them properly instead of rejecting them with broad and sweeping allegations - the TPO has not properly allocated the segmental expenditures - If the bad debts etc. are not related to AE transactions they cannot be considered as part of operating cost for determining ALP of the transactions with AE - Similarly, reimbursement on cost to cost basis also cannot be included in the operating cost - the DRP without dealing with this issue at depth has finished its job by simply commenting that TPO has dealt with the issue appropriately. The decision in M/s. Four Soft Ltd. Hyderabad Versus The Dy. Commissioner of Income-tax, Circle 1(3), Hyderabad 2011 (9) TMI 634 - ITAT, Mumbai followed - For computing the net margin of the assessee for the purposes of transfer pricing, only the cost related to the transaction with the Associated Enterprises has to be considered - segmental financials is to be considered for the purpose of arriving at the net margin on the international transaction with the assessee s enterprise in respect of software development services - In that process, bad debts/reimbursements has to be excluded and segmental profitability has to be adopted - the TPO should have determined the Arm s Length Price for the international transactions with associated enterprises considering only the operating cost allocable to the Associated Enterprises segment the AO had no occasion to verify the veracity of the segmental financials prepared by the assessee company thus, the matter is remitted back to the AO/TPO to determine the ALP only considering the receivables and payables in respect of transactions with AEs only. Selection of comparables - Avani Cimcon Technologies Limited Held that - The assessee has been categorised as a software development service provider the company cannot be treated as comparable as the company is also into product development - As segmental details of operating income of software development services and sale of software products are not available, it could not be ascertained whether the profit ratio of this company can be taken into consideration for comparing with the assessee thus, this company cannot be treated as comparable to the assessee. Infosys Technologies Ltd. & Wipro Limited Extra-ordinarily high turnover - Held that - Both these companies cannot be considered as comparable to the assessee due to various factors such as their size, turnover, brand value, scale of operation, diversified activities and owning of intangibles companies cannot be treated as comparable to the assessee in any manner the AO/TPO is directed to exclude them while computing ALP. ISHIR INFOTECH LTD Held that - The assessee has sought exclusion of the aforesaid company on the ground that this company fails employee cost filter - Ishir Infotech Limited cannot be treated as comparable as it does not qualify the employee cost filter as well as RPT filter - the AO/TPO is directed to exclude this company from the list of comparables. Lucid Software Limited -Held that - The main objection of the assessee that it earns revenue both from product development as well as software services for which segmental data is not available is accepted Relying upon Virtusa (India) (P.) Ltd. Versus Deputy Commissioner of Income-tax 2013 (11) TMI 422 - ITAT HYDERABAD - the company is to be excluded from the comparables because of the segmental data in respect of sale of products and software services are not available thus, the AO/TPO is directed to exclude this company from the list of comparables. Tata Elxsi Limited Held that - Assessee contended that the company cannot be treated as comparable with any other software service provider due to complex nature of its business - thus, the matter remitted back to the AO/TPO for fresh consideration. Megasoft Limited Held that - The main objection of the assessee with regard to the company is that this is predominantly a product development company and margin from software development services is 23.11% is accepted Relying upon Virtusa (India) (P.) Ltd. Versus Deputy Commissioner of Income-tax 2013 (11) TMI 422 - ITAT HYDERABAD - The AO /TPO is directed to take only segmental margin of the company for computing ALP. Determination of arm s length interest rate at 14% for loans provided to Foursoft BV, Netherlands Held that - The decision in M/s. Four Soft Ltd. Hyderabad Versus The Dy. Commissioner of Income-tax, Circle 1(3), Hyderabad 2011 (9) TMI 634 - ITAT, Mumbai followed - The ALP is to be determined for the international transaction, on international loan and not for the domestic loan - Hence, the comparable, in respect of foreign currency loan in the international market, is to be LIBOR based which is internationally recognised and adopted - the DRP rightly directed the assessing officer to adopt the LIBOR plus for the purpose of TP adjustment arm s length price of loan transaction with AE should be on the basis of LIBOR percentage point - the AO/TPO is directed to determine the arm s length interest on loan advanced by assessee to its AE by applying LIBOR percentage points. Re-characterisation of equity into loan Held that - Assessee contended that the loan was extended in view of FEMA regulations - It is also a fact acknowledged by the TPO that the assessee has obtained approval of the RBI for converting the loan into equity - neither the TPO nor DRP have considered the issue at depth thus, the matter is remitted back to the AO / TPO for fresh consideration. Determination of ALP at 3.75% - Corporate guarantee provided by the assessee to its AE Held that - TPO was rightly held that the ALP of the corporate guarantee has to be determined as it falls within the scope and ambit of an international transaction after the retrospective amendment to section 92B - the TPO has applied the rate of 3.75%, which is applicable to bank guarantee issued by the bank- As the corporate guarantee is not in the nature of bank guarantee, the rate applicable to bank guarantee provided by the bank cannot be applied to corporate guarantee which is provided by a group company thus, the matter is remitted back to the TPO to decided the quantum of corporate guarantee rate. Disallowance u/s 14A of the Act Held that - The decision in M/s. Four Soft Ltd. Hyderabad Versus The Dy. Commissioner of Income-tax, Circle 1(3), Hyderabad 2011 (9) TMI 634 - ITAT, Mumbai followed as it was held in Godrej & Boyce vs. DCIT 2010 (8) TMI 77 - BOMBAY HIGH COURT - Rule 8D read with section 14A(2) of the Act is not arbitrary or unreasonable but can be applied only if assessee s method is not satisfactory - Rule 8D is not retrospective in nature and the same has to be applied from the assessment year 2008-09 - For the earlier assessment years, disallowance has to be worked out on reasonable basis under section 14A (2) of the Act thus, the matter is remitted back to the AO for fresh consideration. Disallowance of expenditure - Purchase of software for third parties Held that - The decision in Amway India Enterprises vs. DCIT 2008 (2) TMI 454 - ITAT DELHI-C followed - certain parameters has been laid down for determining the nature of expenditure incurred in acquiring software - The criteria need to be applied to determine the exact nature of expenditure incurred by the assessees for acquiring different softwares - this exercise is required to be done in respect of each and every software independently having regard to the criteria laid down thus, the matter is remitted back to the AO for fresh consideration Decided in favour of Assessee. Computation of exemption u/s 10A of the Act Reduction of certain expenditures only from the export turnover Held that - The AO is directed to reduce such expenses both from export turnover and total turnover while computing exemption under section 10A of the Act

Summary

Issues Involved:
1. Non-application of CUP/TNMM to internal uncontrolled transactions for determining ALP.
2. Inclusion of bad debts and reimbursements in operating cost.
3. Selection of incomparable companies as comparables by TPO.
4. Determination of arm's length interest rate for loans provided to AE.
5. Re-characterization of equity into loan.
6. Determination of ALP on corporate guarantee provided to AE.
7. Disallowance under section 14A of the Act.
8. Treatment of expenditure incurred towards the purchase of software for third parties.
9. Computation of exemption under section 10A by reducing certain expenditures only from the export turnover.
10. Levy of interest under section 234B and 234C of the Act.

Detailed Analysis:

1. Non-application of CUP/TNMM to Internal Uncontrolled Transactions for Determining ALP:
The learned AR argued that the TPO erred in rejecting the CUP method and adopting TNMM for determining ALP due to the use of multiple-year data instead of current financial year data. The TPO's rejection was based on the unreliability of the TP study due to various defects. The Tribunal directed the TPO to reconsider the ALP by properly allocating segmental expenditures and excluding non-related costs like bad debts and reimbursements from operating costs, following the precedent set in the assessee's own case for AY 2006-07.

2. Inclusion of Bad Debts and Reimbursements in Operating Cost:
The Tribunal noted that bad debts and reimbursements should not be included in the operating cost for determining ALP if they are not related to AE transactions. The TPO's inclusion of these costs was found to be erroneous, and the Tribunal directed the TPO to exclude these costs and re-determine the ALP.

3. Selection of Incomparable Companies as Comparables by TPO:
The Tribunal examined the comparability of several companies selected by the TPO:

- Avani Cimcon Technologies Limited: Excluded due to revenue from both products and software services without segmental data.
- Infosys Technologies Ltd. & Wipro Limited: Excluded due to their size, turnover, brand value, and diversified activities, which make them incomparable to the assessee.
- ISHIR INFOTECH LTD: Excluded for failing the employee cost filter.
- Lucid Software Limited: Excluded due to lack of segmental data for product and software services.
- Megasoft Limited: Directed TPO to consider only segmental margin for computing ALP.
- Tata Elxsi Limited: Remitted to TPO for reconsideration of functional differences.

4. Determination of Arm's Length Interest Rate for Loans Provided to AE:
The Tribunal directed the TPO to determine the arm's length interest rate based on LIBOR + percentage points, following the precedent in the assessee's own case for AY 2006-07. The TPO was instructed to consider the assessee's offer of LIBOR + 2%.

5. Re-characterization of Equity into Loan:
The Tribunal remitted the issue back to the TPO to reconsider the re-characterization of equity into a loan after properly examining the agreement and other relevant factual aspects. The TPO was directed to analyze the terms of the loan agreement and consider the RBI approval for converting the loan into equity.

6. Determination of ALP on Corporate Guarantee Provided to AE:
The Tribunal acknowledged that corporate guarantees fall within the scope of 'international transaction' as per section 92B of the Act. The TPO was directed to re-determine the ALP for the corporate guarantee, considering the method adopted in the case of Glenmark Pharmaceuticals, and to consider any comparables brought by the assessee.

7. Disallowance Under Section 14A of the Act:
Following the precedent in the assessee's own case for AY 2006-07, the Tribunal remitted the issue back to the A.O. to rework the disallowance on a reasonable basis, excluding Rule 8D which is applicable from AY 2008-09.

8. Treatment of Expenditure Incurred Towards the Purchase of Software for Third Parties:
The Tribunal directed the A.O. to consider the claim of the assessee by applying the criteria laid down in the Special Bench decision in Amway India Enterprises vs. DCIT. If the expenditure is concluded to be capital in nature, depreciation must be allowed accordingly.

9. Computation of Exemption Under Section 10A by Reducing Certain Expenditures Only from the Export Turnover:
The Tribunal directed the A.O. to reduce such expenses both from export turnover and total turnover while computing exemption under section 10A, following the consistent view of various judicial decisions.

10. Levy of Interest Under Section 234B and 234C of the Act:
The issue of levy of interest under sections 234B and 234C was deemed consequential and not adjudicated upon at this stage.

Conclusion:
The appeal was partly allowed for statistical purposes, with several issues remitted back to the TPO/A.O. for reconsideration and fresh determination in line with the Tribunal's directions. The Tribunal emphasized proper allocation of segmental expenditures, exclusion of non-related costs, and adherence to judicial precedents in determining ALP and other adjustments.