2015 (8) TMI 225 - AT - Income Tax

Transfer pricing adjustment - Computation of Arms Length Price - selection of comparable - Held that - CIT(A) was justified in applying the turnover filter and excluding companies whose turnover was beyond ₹ 200 Crores. No company which was included by the CIT(A) on the basis of the filter of diminishing revenue and therefore the grievance projected by the Revenue is found to be without any basis and hence dismissed. Standard deduction of 5% of the arm s length price allowed to the Appellant by the CIT(A) - 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. TATA Elxsi Ltd was rightly excluded from the list of comparable companies as it is specialised Embedded Software Development Service Provider and that it cannot be compared with any other software development company. Thirdware Solutions Ltd., and Geometric Software Solutions Ltd. were held to be functionally different from a company rendering software development services thus directed to be excluded as relying on case of Sunquest Information Systems (I) Pvt.Ltd 2015 (6) TMI 723 - ITAT BANGALORE M/S.Exensys Software Solutions Ltd company has to be excluded for the reason that it is functionally different from a software development service provider such as the Assessee because it operates three business segments viz., provision of software services, BPO services and software products. Sankhya Infotech Limited ( Sankhya ) company activities set out as compared in the context of a software development company such as the Assessee makes it amply clear that this company Sankhya cannot be regarded as a comparable. The same is directed to be excluded from the list of comparable companies. Bodhtree Consulting Ltd is directed to be excluded from the list of comparable companies as this company has erratic margins and growth over the years. The margins of Bodhtree are consistently changing. This reflects that the revenue recognition policy followed by Bodhtree is not proper and is resulting in consistent change in margins. Further, the growth rate over the years is also fluctuating to extremes. Further, growth in revenues is not supported by growth in expenses. Method of computation of deduction u/s.10A - Held that - Expenses that are reduced from the export turnover should also be reduced from the total turnover .CIT v. Tata Elxsi Ltd 2011 (8) TMI 782 - KARNATAKA HIGH COURT wherein held that 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) for international transactions.
2. Selection and rejection of comparable companies.
3. Application of filters for comparability analysis.
4. Standard deduction under the proviso to Sec.92CA(2) of the Income Tax Act.
5. Computation of deduction under section 10A of the Income Tax Act.

Detailed Analysis:

1. Determination of Arm's Length Price (ALP) for International Transactions:
The primary issue in the appeal and cross-objection pertains to the addition made to the total income consequent to the determination of ALP concerning international transactions entered into by the Assessee with its Associated Enterprises (AE) under section 92 of the Income Tax Act, 1961. The Transfer Pricing Officer (TPO) determined an addition of Rs. 2,12,76,048 due to transfer pricing adjustments. The Assessee used the Transaction Net Margin Method (TNMM) and selected 45 comparable companies, arriving at a profit margin of 10.08%. However, the TPO selected a final set of 17 comparable companies, resulting in an arithmetic mean of 24.51% after working capital adjustment.

2. Selection and Rejection of Comparable Companies:
The CIT(A) excluded several companies from the TPO's list of comparables:
- Geometric Software Solutions Co. Ltd. and Foursoft Ltd.: Excluded due to related party transactions exceeding 10% of turnover.
- Exensys Software Solutions Ltd. and Thirdware Solutions Ltd.: Excluded for being functionally different and having abnormal profits.
- Satyam Computer Services Ltd., L & T Infotech Ltd., Infosys Ltd., Flexotronics Software System (seg), and I gate Global Solutions (Seg.): Excluded due to high turnover exceeding Rs. 200 crores.
- Tata Elxsi Ltd.: Excluded for being functionally different, engaged in niche product development.

3. Application of Filters for Comparability Analysis:
The CIT(A) applied various filters, including:
- Related Party Transaction (RPT) Filter: Applied a threshold of 10% of turnover for related party transactions.
- Turnover Filter: Excluded companies with turnover exceeding Rs. 200 crores, following the ITAT Bangalore Bench's decision in the case of M/S. Genesys Integrating Systems (I) Pvt. Ltd.
- Functional Similarity: Excluded companies engaged in different business models or having abnormal profits.

4. Standard Deduction Under the Proviso to Sec.92CA(2):
The CIT(A) allowed a 5% standard deduction under the proviso to Sec.92CA(2) of the Act. However, it was held 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 under the proviso to Sec.92C(2) could be allowed.

5. Computation of Deduction Under Section 10A:
The AO excluded telecommunication expenses from the export turnover while computing the deduction under section 10A, which was contested by the Assessee. The CIT(A) allowed the alternate prayer that expenses reduced from the export turnover should also be reduced from the total turnover, aligning with the Karnataka High Court's decision in CIT v. Tata Elxsi Ltd.

Conclusion:
The Tribunal partly allowed both the Revenue's appeal and the Assessee's cross-objection. The Tribunal upheld the CIT(A)'s decision to exclude certain companies based on related party transactions, turnover, and functional dissimilarity. It also maintained the CIT(A)'s decision on the standard deduction under Sec.92CA(2) and the computation of deduction under section 10A. The Tribunal remanded the issue of determining the correct RPT percentage to the AO/TPO for further examination.