2015 (11) TMI 64 - AT - Income Tax

Transfer pricing adjustment - Computation of Arms Length Price - Held that - E-Zest Solutions Ltd. to be excluded from the list of comparable companies chosen by the TPO as KPO services are not comparable to software development services and are therefore not comparable. Infosys Technologies Ltd., Tata Elxsi Ltd. and Wipro Ltd. held to be functionally not comparable with a software development service provider such as the Assessee in the case of 3DPLM Software Solutions Ltd. 2014 (12) TMI 612 - ITAT BANGALORE and 24/7 Customer.Com Pvt. Ltd. 2013 (1) TMI 45 - ITAT BANGALORE Celestial Biolabs Ltd. is not a comparable company with a software development service provider such as the Assessee Avani Cincom Technologies Ltd. and KALS Information Systems Ltd. be omitted from the list as is functionally dis-similar and different from the assessee and hence is not comparable. TPO/AO is directed to compute the arithmetic mean of the remaining comparable companies and allow adjustment of / - 5% of the net margin as contemplated by the provisions of Sec.92C of the Act, if the Assessee is entitled to such adjustment as a result of exclusion of the comparable companies.

Summary

Issues Involved:
1. Determination of Arm's Length Price (ALP) for international transactions under Section 92 of the Income Tax Act, 1961.
2. Validity of comparable companies selected by the Transfer Pricing Officer (TPO) and their exclusion by the Commissioner of Income Tax (Appeals) [CIT(A)].
3. Application of turnover filter and other filters for comparability analysis.
4. Functional dissimilarity of certain comparable companies with the assessee.

Detailed Analysis:

1. Determination of Arm's Length Price (ALP):
The primary issue was the addition made to the total income of the assessee, a subsidiary of a US-based company, due to the determination of ALP concerning international transactions. The assessee used the Transaction Net Margin Method (TNMM) to justify the price charged for software development and support services provided to its Associated Enterprises (AE). The TPO, however, adjusted the ALP, resulting in an addition of Rs. 7,20,13,370, which was contested by both the assessee and the Revenue.

2. Validity of Comparable Companies:
The TPO had selected 20 comparable companies to determine the ALP, which included companies like Infosys Ltd., Tata Elxsi Ltd., and Wipro Ltd. The CIT(A) excluded certain companies based on turnover and functional dissimilarity, reducing the addition significantly. The Tribunal upheld the CIT(A)'s decision to exclude companies with turnover exceeding Rs. 200 crores and those functionally dissimilar, such as Celestial Biolabs Ltd., Avani Cincom Technologies Ltd., and KALS Information Systems Ltd.

3. Application of Turnover Filter and Other Filters:
The CIT(A) applied a turnover filter, excluding companies with turnover greater than Rs. 200 crores, aligning with the Tribunal's consistent stance that significant differences in size impact comparability. The Tribunal referenced several cases, including Trilogy e-business Software India Pvt. Ltd., to support this filter. The Tribunal also upheld the CIT(A)'s rejection of the TPO's additional filters like diminishing revenue, different year ending, and employee cost filters, as they were not applied by the CIT(A) in excluding any comparables.

4. Functional Dissimilarity:
The Tribunal emphasized the functional dissimilarity of certain companies from the assessee. For instance, Infosys Ltd. was excluded due to its substantial brand value, ownership of intellectual property rights, and market leadership, which made it incomparable to a captive service provider like the assessee. Similarly, Tata Elxsi Ltd. and Wipro Ltd. were excluded for their engagement in product development and ownership of significant intangibles, which differentiated them from the assessee's software development services. The Tribunal relied on prior decisions, including the assessee's own case for the previous assessment year, to affirm these exclusions.

Conclusion:
The Tribunal directed the TPO/AO to recompute the arithmetic mean of the remaining comparable companies and apply the + / - 5% adjustment as per Section 92C of the Income Tax Act. The appeal by the assessee was partly allowed, while the Revenue's appeal was dismissed. The decision underscored the importance of functional comparability and appropriate filters in transfer pricing analysis.