2014 (7) TMI 181 - AT - Income Tax

Transfer pricing adjustment Selection of comparables - Accel Transmatic Ltd.- Held that - The TPO has drawn conclusions on the basis of information obtained by issue of notice u/s.133(6) of the Act - This information which was not available in public domain could not have been used by the TPO, when the same is contrary to the annual report of this company as highlighted by the Assessee in its letter dated 21.06.2010 to the TPO the company was developing software products and not purely or mainly software development service provider thus, this company cannot be taken as comparable. Megasoft Ltd. Infosys Technologies Ltd. - Held that - The TPO has accepted the fact that the assessee is purely a software development service provider to its AE whereas Infosys is not a captive service provider like assessee - Infosys is engaged in diversified activities and also engaged in development of products consultancy and solution - That apart, the size, reputation and brand value of Infosys, in no way makes it comparable to a small captive service provider like assessee. Though the assessee has advanced detailed submissions for inclusion of the aforesaid companies, but, the DRP has simply brushed aside the same without considering in proper perspective - the assessee s contention in respect of the companies requires reconsideration - so far as L&T Infotech Ltd. is concerned, this company is having a huge turnover of 790 crores and unlike the assessee it is not captive service provider - Therefore, the reasons for which Infosys Technologies Ltd cannot be treated as comparable to the assessee also equally applies to this company - except L&T Infotech Ltd., the comparability of the other companies selected by the assessee, but, rejected by the TPO is restored back to the file of the AO/TPO for fresh consideration. Exclusion of communication expenses Held that - The decision in CIT Vs. Gemplus Jewellery 2010 (6) TMI 65 - BOMBAY HIGH COURT followed a receipt such as freight and insurance which does not have any element of profit cannot be included in the total turnover - Freight and insurance do not have an element of turnover - these two items would have to be excluded from the total turnover particularly in the absence of a legislative prescription to the contrary thus, the AO is directed to exclude the communication expenses from export turnover as well as total turnover while computing deduction u/s 10A of the Act Decided partly in favour of Assessee.

Issues Involved:
1. Transfer Pricing Issues
2. Risk Adjustment
3. Exclusion of Communication Expenses from Export Turnover
4. Levy of Interest under Section 234B
5. Initiation of Proceedings under Section 271(1)(c)

Detailed Analysis:

1. Transfer Pricing Issues:
The primary issue revolves around the selection and rejection of comparables by the Transfer Pricing Officer (TPO) and the Dispute Resolution Panel (DRP). The assessee, an Indian company providing software development services to its Associated Enterprise (AE) in the USA, adopted the Transaction Net Margin Method (TNMM) and selected 36 comparables. The TPO rejected the assessee's study, citing defects and deficiencies, and selected 20 comparables with an average margin of 20.68%. The TPO's adjustments led to an addition of Rs. 1,58,53,227/- to the assessee's income.

The assessee objected to five comparables selected by the TPO:
- Accel Transmatic Ltd.: The company was functionally different, involved in selling IP rights, and had a high related party transaction (RPT) ratio of 60.60%. The Tribunal excluded this company, citing functional dissimilarity and high RPT.
- KALS Info Systems Ltd.: Similar reasons for exclusion as Accel Transmatic Ltd., including functional differences and involvement in product sales.
- Megasoft Ltd.: The Tribunal directed the TPO to consider only the software development services segment for comparability.
- Infosys Technologies Ltd.: Excluded due to its diversified activities, brand value, and economies of scale, making it incomparable to the assessee.
- Tata Elxsi Ltd.: Excluded due to its specialized embedded software development, making it functionally different from the assessee.

The assessee also objected to the rejection of seven comparables by the TPO:
- VMF Softech Ltd.: Rejected by the TPO based on employee cost filter, but the Tribunal noted the need for reconsideration as the employee cost was approximately 62% of sales.
- TVS Infotech Ltd.: Rejected as a persistent loss-making company, but the Tribunal noted it had an operating profit for FY 2004-05.
- PSI Data Systems Ltd.: Rejected due to alleged product sales and non-response to notice, but the Tribunal noted the need for reconsideration as there was no evidence of product development.
- Larsen & Toubro Infotech Ltd.: Rejected due to a huge turnover and non-captive service provider status, similar to Infosys.
- Birla Technologies Ltd.: Rejected based on RPT filter, but the Tribunal noted the need for reconsideration as the RPT was only 3.07%.
- Goldstone Technologies Ltd.: Rejected as a BPO service provider, but the Tribunal noted the need for reconsideration based on the company's annual report.
- Quintegra Solutions Ltd.: Rejected as predominantly on-site, but the Tribunal noted the need for reconsideration based on foreign exchange expenditure.

2. Risk Adjustment:
The issue of risk adjustment was raised by the assessee but was deferred for reconsideration based on the final outcome of the comparables' selection/rejection. The Tribunal directed the TPO to reconsider the risk adjustment if necessary, after determining the margins with the revised comparables.

3. Exclusion of Communication Expenses from Export Turnover:
The assessee challenged the exclusion of communication expenses from the export turnover while computing the deduction under Section 10A. The Tribunal directed the AO to exclude the communication expenses from both export turnover and total turnover, following the decisions in CIT Vs. Gemplus Jewellery and ITO Vs Saksoft Ltd.

4. Levy of Interest under Section 234B:
The levy of interest under Section 234B was considered consequential and not required to be addressed at this stage. The Tribunal dismissed this ground as infructuous.

5. Initiation of Proceedings under Section 271(1)(c):
The initiation of proceedings under Section 271(1)(c) was deemed premature for consideration at this stage and was dismissed accordingly.

Conclusion:
The appeal was partly allowed, with the Tribunal directing the reconsideration of certain comparables and adjustments, while providing specific directions on the exclusion of communication expenses and dismissing certain grounds as premature or consequential.

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