2015 (6) TMI 723 - AT - Income Tax

Transfer pricing adjustment - CIT(A) allowed partial relief to assessee - selection of comparables - improper application of the RPT filter by the CIT(A) as per revenue - Held that - It is not in dispute before us that this Tribunal, in the cases of 24/7 Customer Pvt. Ltd. ( 2013 (1) TMI 45 - ITAT BANGALORE), Sony India Private Ltd. reported in (2008 (9) TMI 420 - ITAT DELHI-H ) and various other cases has taken a view that comparables having RPT of upto 15% of total revenues can be considered. In view thereof, the Revenue s grievance on this issue as projected in ground No.2 has to be allowed. It is held that the CIT(A) ought to have adopted a threshold limit of 15% of the total revenue attributable to related party transaction as ground for rejecting comparable companies. Consequently it is held that comparable companies having RPT upto 15% of the total revenues alone can be excluded. CIT(A) rejected some of the comparable companies chosen by the TPO by applying related party transaction filter - Held that - The filter of companies dealing in software products and abnormal profits owing to amalgamation of the companies during the relevant period thereby showing abnormal profits was applied to exclude Exensys Software solutions Ltd. Infosys Technologies Ltd., was excluded for reasons of high turnover and high risk profile. Satyam Computer Services Ltd., has to be excluded from the comparable companies for non-reliability of financial data as it was involved in financial scam as relying on Agnity India Technologies v. ITO 2010 (11) TMI 852 - ITAT DELHI . Thus CIT(A) rightly excluded Exensys Software Solutions Ltd., Infosys Technologies Ltd., and Satyam Computers Ltd., from the list of comparable companies. - Decided against revenue. Standard deduction of 5% of the arm s length price allowed to the Appellant by the CIT(A) - Held that - In view of the substitution of the Second proviso to Section 92C(2) of the Income-tax Act by the Finance (No.2) Act, 2009 t is held that if the difference between the arithmetic mean of the profit margins comparable companies ultimately retained and the profit margin of the Assessee is more than 5% than no deduction under the proviso to Sec.92C(2) of the Act could be allowed to an Assessee. Selection of comparables - Held that - Having taken note of the difference between the two functions, the Assessing Officer ought not to have taken the companies which are into both the product development as well as software development service provider as comparables unless the segmental details are available. Even if he has adopted the filter of more than 75% of the revenue from the software services for selecting a comparable company, he ought to have taken the segmental results of the software services only. As seen from the annual report of Foursoft Limited which is reproduced at page 7 of the TPO s Order, the said company has derived income from software licence also and AMCs. As far as Thirdware Software Solution Limited is concerned, we find from the information furnished by the said company that though the said company is also into product development, there are no software products that the company invoiced during the relevant financial year and the financial results are in respect of services only. Thus, it is clear that there is no sale of software products during the year but the said company might have incurred expenditure towards the development of the software products. As far as Flextronics Software Limited is concerned, the method adopted by the TPO to allocate expenditure proportionately to the software development services and software product activity cannot be said to be correct and reasonable. Wherever, the Assessing Officer/TPO cannot make suitable adjustment to the financial results of the comparable companies with the assessee company to bring them on par with the assessee, these companies are to be excluded from the list of comparables. Therefore, we direct the Assessing Officer/TPO to exclude these three companies from the list of comparables. TATA Elxsi Ltd.should be excluded from the list of comparable companies as not comparable with that of a software development service provider such as the Assessee. Gate Global Solutions Ltd., Flextronics Software Systems Ltd., L & T Infotech Ltd. and Infosys Ltd., will have to be rejected applying the upper limit of ₹ 200 crores turnover in view of the decision of the Tribunal in the case of Trilogy E-Business Software India Pvt.Ltd. 2013 (1) TMI 672 - ITAT BANGALORE The AO is directed to compute the Arithmetic mean by excluding the aforesaid companies from the list of comparable. According to the learned counsel for the Assessee, if the submissions of the assessee are accepted, then the arithmetic mean of the comparables retained would be within the range of /- 5% of the Assessee s Net Margin Method of computation of deduction u/s.10A - Held that - Taking into consideration the decision rendered by the Hon ble High Court of Karnataka in the case of CIT v. Tata Elxsi Ltd 2011 (8) TMI 782 - KARNATAKA HIGH COURT it is held whatever is excluded from the export turnover should also be excluded from the total turnover for the purpose of computing deduction u/s.10A of the Act. - Decided in favour of assessee.

Summary

Issues Involved:
1. Determination of Arm's Length Price (ALP) in respect of international transactions.
2. Application of filters for choosing comparable companies.
3. Exclusion of companies with related party transactions (RPT).
4. Exclusion of companies with abnormal profits and high turnover.
5. Entitlement to standard deduction under the proviso to Sec.92CA(2) of the Income Tax Act.
6. Computation of deduction under Section 10A of the Income Tax Act.

Detailed Analysis:

1. Determination of Arm's Length Price (ALP):
The primary issue in the appeal by the Revenue and the cross-objection by the Assessee was the addition made to the total income due to the determination of ALP for international transactions with its Associated Enterprises (AE) under Section 92 of the Income Tax Act. The Transfer Pricing Officer (TPO) determined an adjustment of Rs. 2,36,04,205 based on the profit margins of 17 comparable companies.

2. Application of Filters for Choosing Comparable Companies:
The Assessee raised objections to the methodology adopted by the TPO in selecting comparable companies. The CIT(A) applied filters to exclude certain companies, such as those with related party transactions or those that were functionally dissimilar. The Tribunal upheld the CIT(A)'s decision to exclude companies with related party transactions exceeding 15% of total revenues, in line with the Tribunal's decisions in similar cases.

3. Exclusion of Companies with Related Party Transactions (RPT):
The CIT(A) excluded 10 out of 17 companies chosen by the TPO due to related party transactions. The Tribunal agreed with the CIT(A) that companies with RPT exceeding 15% should be excluded. This decision was based on precedents set by the Tribunal in other cases, such as 24/7 Customer Pvt. Ltd. and Sony India Private Ltd.

4. Exclusion of Companies with Abnormal Profits and High Turnover:
The CIT(A) excluded companies like Exensys Software Solutions Ltd., Thirdware Solutions Ltd., Satyam Computer Services Ltd., and Infosys Technologies Ltd. for reasons including abnormal profits, high turnover, and unreliability of financial data. The Tribunal upheld these exclusions, referencing decisions in similar cases by the ITAT Bangalore and Delhi Benches.

5. Entitlement to Standard Deduction under Sec.92CA(2):
The CIT(A) allowed a standard deduction of 5% under the proviso to Sec.92CA(2), which the Revenue contested. The Tribunal noted that if the difference between the arithmetic mean of the profit margins of comparable companies and the Assessee's profit margin exceeds 5%, no deduction is permissible under the proviso to Sec.92C(2).

6. Computation of Deduction under Section 10A:
The AO excluded telecommunication expenses from the export turnover while computing deduction under Section 10A, which the CIT(A) reversed. The Tribunal upheld the CIT(A)'s decision, referencing the Karnataka High Court's ruling in CIT v. Tata Elxsi Ltd., which mandates that expenses excluded from export turnover should also be excluded from total turnover.

Conclusion:
The Tribunal partly allowed the appeal by the Revenue and the cross-objection by the Assessee. It directed the AO to compute the arithmetic mean by excluding certain companies from the list of comparables and upheld the CIT(A)'s decision on the computation of deduction under Section 10A. The Tribunal's decisions were based on established precedents and detailed analysis of the functional comparability of the companies involved.