2015 (10) TMI 483 - AT - Income Tax

Transfer pricing adjustment - selection of comparable - Held that - Accentia Technologies Ltd. (Seg.) - as during the previous year there were extra ordinary events that took place in this company which warrants exclusion of this company as a comparable. We therefore hold that this company cannot be considered as a comparable. Acropetal Technologies Ltd. (Seg.) - On a perusal of the Note No.15 of notes to accounts which gives segmental revenue of this company, it is clear that the major source of income for this company is from providing Engineering Design Service and Information Technology Services. The functions performed by the Engineering Design Services segment of the company cannot be considered as comparable to the ITES/BPO functions performed by the Assessee. The performance of Engineering Design Services is regarded as providing high end services among the BPO which requires high skill whereas the services performed by the Assessee are routine low end ITES functions. We therefore hold that this company could not have been selected as a comparable, especially when it performs engineering design services which only a Knowledge Process Outsourcing KPO would do and not a Business Process Outsourcing BPO . Coral Hubs Ltd. cannot be considered as a comparable - It may also be relevant to point out that the TPO in his order has observed that this company is retained as a comparable on the basis of detailed discussion in the TP order for the A.Y. 2007-08. In fact in A.Y. 2007-08, there was no determination of ALP and therefore there was no occasion for any order being passed by the TPO. It is also seen that this company entered into an area of business known as New Vertical Digital Library & Print on Demand in F.Y. 2007-08. Crossdomain Solutions Ltd. - It is seen that the business profile of this company is re-engineered payroll service. This company is also engaged in the development of information systems. These activities are totally different from the activities of the assessee which perform very limited/low end functions back office services. The business of Cross Domain ranges from high end KPO services, development of product suites and routine low end ITES service. However, there is no bifurcation available for such verticals of services. Therefore the assessee contends that Cross Domain cannot be compared to a routine ITES service provider. We are of the view that in the absence of any reasons given to the contrary either by the TPO or the DRP for regarding this company as a comparable, this company should be excluded from the list of comparables, accepting the plea of the Assessee Eclerx Services Ltd. cannot be regarded as a comparable for the reason that it was functionally different. Infosys BPO Ltd. - chedule 13 to the profit & loss account of this company for the F.Y. 2007-08 shows that this company incurred huge selling and marketing expenses. Page 133 of the annual report of this company for the F.Y. 2007-08 shows that this company realizing its brand value has chosen to value the same on the basis of its earnings and that of Infosys. The brand value of the Assessee and Infosys has been valued at ₹ 31,863 Crores. Infosys BPO, being a subsidiary of Infosys, has an element of brand value associated with it. This is also clear from the presence of brand related expenses incurred by this company. Presence of a brand commands premium price and the customers would be willing to pay, for the services/products of the company. Mold-tek Technologies Ltd. - submission of the assessee before us is that it is in the business of Knowledge Process Outsourcing and cannot be considered as a comparable. Wipro Ltd. company owns substantial intellectual property on software products. This company cannot therefore be regarded as a comparable. For the reasons given while disregarding Infosys BPO Ltd. as a comparable, this company is also directed to be excluded from the list of comparables. Hon ble High Court of Karnataka in the case of CIT v. Tata EIxsi Ltd 2011 (8) TMI 782 - KARNATAKA HIGH COURT has held that while computing deduction under section 10A of Act, expenditure incurred by the assessee, if excluded from the export turnover, should also be excluded from the total turnover. In view of the aforesaid decision of the Hon ble High Court of Karnataka, the AO is directed to reduce the expenses incurred for travelling and internet connection charges from the export turnover as well as the total turnover, while computing deduction u/s. 10A of the Act. We hold and direct accordingly. Similarly in the additional ground, the assessee has prayed that the foreign exchange loss should also be added to the total turnover and export turnover as against the action of the AO in excluding the said loss only from the Export turnover following the decision in the case of TATA ELXSI (supra) of the Hon ble Karnataka High Court. We held that the said loss should be excluded both from ETO and TTO. We hold and direct accordingly. - Decided in favour of assessee

Summary

Issues Involved:
1. Validity of the assessment order.
2. Transfer Pricing adjustments and determination of Arm's Length Price (ALP).
3. Rejection of Transfer Pricing documentation and analysis.
4. Use of single-year financial data vs. multiple/prior year data.
5. Rejection and acceptance of comparable companies.
6. Application of additional filters by the Transfer Pricing Officer (TPO).
7. Use of information obtained under Section 133(6) of the Income-tax Act.
8. Computation errors in operating margins.
9. Non-acceptance of working capital and risk adjustments.
10. Application of the 5 percent range for transfer pricing adjustments.
11. Re-computation of relief under Section 10A of the Income-tax Act.
12. Exclusion of foreign currency expenditure from export turnover.
13. Reduction of communication expenses from export turnover.
14. Exclusion of certain expenses from total turnover for Section 10A computation.
15. Levy of interest under Sections 234B and 234D of the Income-tax Act.
16. Additional ground regarding foreign exchange losses.

Detailed Analysis:

1. Validity of the Assessment Order:
The assessee argued that the assessment order dated October 22, 2012, passed by the Assessing Officer (AO) following the directions of the Dispute Resolution Panel (DRP), was not in accordance with the law, contrary to the facts, and violated principles of equity and natural justice.

2. Transfer Pricing Adjustments and Determination of ALP:
The DRP and AO confirmed the TPO's adjustment of Rs. 91,14,06,057 to the price charged for international transactions, upholding an ALP margin of 25.90% against the appellant's determined ALP of 13.31%.

3. Rejection of Transfer Pricing Documentation and Analysis:
The DRP and AO upheld the TPO's rejection of the appellant's Transfer Pricing documentation, including the detailed Functions, Assets, Risk, and benchmarking analysis.

4. Use of Single-Year Financial Data vs. Multiple/Prior Year Data:
The DRP and AO upheld the TPO's decision to disregard multiple/prior year data considered by the appellant and instead adopted single-year financial data for FY 2007-08.

5. Rejection and Acceptance of Comparable Companies:
The TPO rejected certain comparable companies identified by the appellant using what the appellant argued were unreasonable comparability criteria. The TPO accepted 7 comparables from the appellant's list and added 13 more, resulting in a final set of comparables.

6. Application of Additional Filters by the TPO:
The DRP and AO upheld the TPO's application of additional filters, finalizing the transfer pricing order with companies deemed comparable despite failing tests of comparability on various factors.

7. Use of Information Obtained Under Section 133(6):
The DRP and AO upheld the TPO's use of information obtained under Section 133(6) of the Income-tax Act, despite inconsistencies with publicly available information.

8. Computation Errors in Operating Margins:
The DRP and AO upheld the TPO's computation of operating margins, which the appellant argued contained factual errors and ignored certain items that should have been considered as operating or non-operating.

9. Non-Acceptance of Working Capital and Risk Adjustments:
The DRP and AO upheld the TPO's rejection of the appellant's claim for working capital and risk adjustments.

10. Application of the 5 Percent Range for Transfer Pricing Adjustments:
The DRP and AO upheld the TPO's adjustment without considering the upper range of 5 percent from the value of the international transaction, as allowed under the Act and Income-tax Rules.

11. Re-computation of Relief Under Section 10A:
The AO re-computed the relief under Section 10A of the Act at Rs. 46,96,88,074/- against the appellant's claimed amount of Rs. 50,10,42,467/-.

12. Exclusion of Foreign Currency Expenditure from Export Turnover:
The DRP upheld the AO's action of excluding foreign currency expenditure incurred for rendering technical services outside India from the export turnover for Section 10A computation.

13. Reduction of Communication Expenses from Export Turnover:
The DRP and AO reduced an amount of Rs. 1,87,30,103 pertaining to link charges from the export turnover, even though the appellant had already reduced this amount while computing the relief under Section 10A.

14. Exclusion of Certain Expenses from Total Turnover for Section 10A Computation:
The DRP and AO held that communication expenses, insurance expenses, and foreign currency expenses should not be reduced from total turnover for Section 10A computation, even if reduced from export turnover.

15. Levy of Interest Under Sections 234B and 234D:
The DRP and AO levied interest under Sections 234B and 234D of the Income-tax Act.

16. Additional Ground Regarding Foreign Exchange Losses:
The appellant argued that foreign exchange losses should be added back to both total turnover and export turnover. The Tribunal admitted this additional ground for adjudication, referencing the Karnataka High Court's decision in Tata Elxsi Ltd. (349 ITR 98), which upheld that if export turnover is adjusted for certain expenses, the total turnover should also be adjusted accordingly.

Conclusion:
The Tribunal excluded several companies from the list of comparables, leading to an arithmetic mean of 11.25% for the remaining comparables, which was lower than the appellant's margin of 9.66%. Therefore, no adjustment to the ALP was required. The Tribunal directed the AO to follow the Karnataka High Court's decision in Tata Elxsi Ltd. regarding the exclusion of expenses from both export turnover and total turnover for Section 10A computation. The appeal by the assessee was allowed.