2014 (9) TMI 143 - AT - Income Tax

Determination of ALP International transaction with AE - validity, legality and propriety of the procedure adopted by the TPO Held that - The assessee has used data of different companies pertaining to the period from April, 2001 to February 16, 2004 - the assessee has used data of the preceding two financial years and partly of the current financial year, from April 1, 2003 to February 16, 2004 - under Indian Transfer Pricing Regulation, for the purpose of comparability analysis, an assessee is bound to use the data of relevant financial year, in which it has entered into international transaction - Under Rule 10B(4), it says the data to be used in analyzing the comparability of an uncontrolled transaction with an international transaction, shall be the data relating to the financial year in which the international transaction has been entered into. Thus, as per the above provisions, user of data of the current financial year, in which international transaction has been entered into by an assessee, is mandatory. There is no option but to use the data of only the relevant financial year, in which the international transaction has been entered into by the assessee, for comparability analysis - Though, in the proviso below the Rule 10B(4), it says that data relating to the preceding two financial years may also be considered, if data reveals facts which could have an influence on determination of transfer prices in relation to the transactions being compared, since in the instant case, the assessee has not been able to reveal any facts pertaining to the earlier financial years which had an influence on the determination of transfer prices with reference to those comparable companies, the TPO justified in using the data of only the current financial year 2003-04, for determining the ALP relying upon Honeywell Automation India Ltd. v. Dy. CIT 2009 (2) TMI 736 - ITAT PUNE Decided against Assessee. Selection of comparables Exclusion of gain on account of foreign exchange fluctuation Held that - The exchange fluctuation gains arise out of several factors, for instance, realisation of export proceeds at higher rate, import dues payable at lower rate - the gain or loss is on account of exchange fluctuation arising in the normal course of business transaction, it should be considered while computing the net margin for the international transactions with the AEs of the assessee relying upon SAP LABS India Ltd.(P.) Ltd. v. ACIT 2010 (8) TMI 676 - ITAT, BANGALORE - if the gain on account of foreign exchange rate fluctuation is to be taken as operating gain in nature, the net margin declared by the assessee for the international transaction with the AEs, goes up still further - if the loss of the comparable is abnormal and there is no trading activity of whatsoever, data of such company cannot be considered the AO is directed to consider the data of MCS Ltd. as comparable while computing the ALP and to exclude other two companies from comparables. Loss making companies to be treated as comparable or not Held that - Determining of ALP is depend upon the comparables of identical or similar in controlled transactions in similar or comparable circumstances and thereafter suitable adjustment has to be made to set off the difference to make the transaction commercially comparable - only abnormal loss making companies are to be taken out from the comparables relying upon DCIT Versus Quark Systems Pvt. Ltd. 2009 (10) TMI 591 - ITAT, CHANDIGARH - when companies which are loss making are excluded from comparables, then super profit making companies are also to be excluded from the comparables for determining the ALP- the AO has to recalculate the ALP after excluding only the data of the companies which have losses due to extraordinary reasons Decided in favour of Assessee. Controlled transaction with related parties Held that - Related party disclosure in Ace Annual Report shows no services are provided to Apex Data Services - Relationship has to be examined as per definition of Associated Enterprises (AEs) as per section 92A of the Act - Apex Data Services is having 7% share capital in Ace Software Exports Ltd. - Even otherwise provisions of section 92A(2)(i) deems two companies as AEs only, if 100% goods are purchased and sold - Though the transactions with related parties cannot be considered for the purpose of comparison, in the present case considering the facts, rejection is not justified Decided in favour of Assessee. Computation of net margin Held that - Segmental financial data is to be considered for the purpose of arriving at the net margin on an international transaction with the assessee's enterprises in respect of transactions carried on by the assessee - segmental data of the company F.I. Sofex Ltd., ought to be considered as comparable if there is normal loss - there is abnormal loss on account of extraordinary reasons, then it is not comparable and to be excluded from comparables Decided in favour of Assessee. Salary cost as percentage of the total cost is very abnormal - Held that - The employee's cost to total cost ratio is worked out at 2% as compared to the industry average of 30 to 40% - The assessee's employee's cost to total cost ratio is worked out at 47% - the employee's cost form major cost base in ITES service industries, the low ratio of comparables implies that it would not be providing services by employing its own sources - the assessee is not alike to M/s. Vishal Information Technologies Ltd. Accordingly, M/s. Vishal Information Technologies Ltd., cannot be considered as comparables and it is to be excluded from comparables. Computation of deduction u/s 10A Reduction of communication expenses - Held that - Following the decision in ITO v. Sak Soft Ltd. 2009 (3) TMI 243 - ITAT MADRAS-D - for the purpose of applying the formula under subsection (4) of section 10B, the freight, telecom charges and insurance attributable to the delivery of articles or things or computer software outside India or the expenses, if any, incurred in foreign exchange in providing the technical services outside India are to be excluded both from the export turnover and from the total turnover, which are numerator and denominator, respectively in the formula the order of the CIT(A) is upheld. Expenditure pertaining to internet services utilised from VSNL Payment falls under the category of fees for technical services or not Failure to deduct TDS Held that - In availing such service facility from VSNL, there is involvement of human skill - efforts of technical personnel were involved in availing the said internet connection and the incidental services availed from VSNL - payment made by the assessee to that service provider has to be treated as fees for technical services and hence the assessee was under obligation to deduct tax at source from the same thus, for non deduction of tax at source, the AO was justified in disallowing the amount u/s. 40(a)(ia) of the Act Decided against Assessee. Ad-hoc disallowance @ 15% upheld - Rent, electricity charges, communication charges, insurance and foreign exchange loss excluded Held that - Though the assessee has clarified about the nature of various expenditure claimed by it, it has not been explained as to why and under which circumstances it could not produce the books of accounts and those bills and vouchers for verification before the AO during the assessment proceedings - the assessee has not produced the books of accounts and bills and vouchers for verification on that date the action of the CIT(A) in disallowing a part of expenses claimed by the assessee is upheld.

Summary

Issues Involved:
1. Reduction of communication expenses from export turnover for computing deduction under section 10A.
2. Determination of Arm's Length Price (ALP) for international transactions.
3. Selection and rejection of comparables for transfer pricing.
4. Adjustment towards working capital differences.
5. Exclusion of communication charges from export turnover.
6. Disallowance of expenditure for internet services utilized from VSNL.
7. Ad-hoc disallowance of 15% of expenditure excluding certain charges.
8. Additional ground regarding additions inflating business income qualifying for exemption under section 10A.

Detailed Analysis:

1. Reduction of Communication Expenses from Export Turnover:
The Assessing Officer (AO) excluded communication expenses from the export turnover while computing the deduction under section 10A. This was based on the definition of 'export turnover' in clause (iv) to Explanation-2 to section 10A, which excludes freight, telecommunication charges, and insurance attributable to the delivery of articles outside India. The CIT(A) confirmed this reduction but also ruled that these expenses should be excluded from the total turnover as well. This approach was upheld by the Tribunal, aligning with the decision in ITO v. Sak Soft Ltd. [121 TTJ (Chennai) (SB) 865].

2. Determination of Arm's Length Price (ALP):
The AO referred the determination of ALP to the Transfer Pricing Officer (TPO) who adjusted the ALP of international transactions, leading to an addition of Rs. 4,68,54,433 to the assessee's income. The TPO used contemporaneous data from the financial year 2003-04, excluding some comparables provided by the assessee and including others. This approach was justified under Rule 10B(4) of the Income-tax Rules, 1962, which mandates using data from the relevant financial year.

3. Selection and Rejection of Comparables:
Several comparables were disputed by the assessee:
- Rejected by TPO but disputed by Assessee: Tata Services Ltd., Ace Software Exports Ltd., C.S. Software Enterprises Ltd., MCS Ltd., Mukund Engineers Ltd., F.I. Sofex Ltd., Vans Information Ltd., Suprawin Technologies Ltd., Tulsyan Technologies Ltd.
- Accepted by TPO but rejected by Assessee: Ultramarine & Pigments Ltd., Vishal Information Technologies Ltd., Wipro BPO Ltd., Spanco Telesystems & Solutions Ltd.
The Tribunal directed the AO to reconsider certain comparables based on functional similarities, segmental data, and exclusion criteria for loss-making companies and those with extraordinary profits. The Tribunal emphasized the importance of using only operating profits for comparability and excluded companies with significant functional differences or those operating on a no-profit-no-loss basis.

4. Adjustment Towards Working Capital Differences:
The Tribunal allowed the assessee's plea for adjustment towards working capital differences at 2%, in line with the decisions in Logix Micro Systems Ltd. v. Asstt. CIT and Tally Solutions Pvt. Ltd. v. DCIT.

5. Exclusion of Communication Charges from Export Turnover:
The Tribunal reiterated that communication charges should be excluded from both export turnover and total turnover for computing deduction under section 10A, as decided in earlier paras and supported by the Special Bench decision in Sak Soft Ltd.

6. Disallowance of Expenditure for Internet Services Utilized from VSNL:
The AO disallowed Rs. 13,09,362 for internet services from VSNL, treating it as fees for technical services requiring tax deduction at source (TDS). The Tribunal upheld this disallowance, distinguishing it from the Skycell Communications Ltd. case and emphasizing the involvement of human skill in providing such services.

7. Ad-hoc Disallowance of 15% of Expenditure:
The AO disallowed 15% of certain expenditures due to the assessee's failure to produce books of accounts and vouchers for verification. The Tribunal upheld this disallowance, noting the assessee's inability to justify the expenses during the assessment proceedings.

8. Additional Ground Regarding Additions Inflating Business Income Qualifying for Exemption under Section 10A:
The Tribunal admitted the additional ground and ruled in favor of the assessee, relying on the Bombay High Court decision in CIT v. Gem Plus Jewellery India Ltd., which held that additions made under the business head should qualify for exemption under section 10A.

Conclusion:
The appeals were partly allowed, with the Tribunal providing detailed directions on the treatment of comparables, adjustments for working capital differences, and the computation of deductions under section 10A. The Tribunal emphasized the need for functional comparability and the proper application of transfer pricing regulations.