2016 (1) TMI 1367 - AT - Income Tax

Selection of comparables - determination of arm s length price - functional similarity - Held that - Excessive profits or abnormal loss by itself would not be a reason for exclusion of a company from the list of comparables which was otherwise similar to the tested party - it was not a case where exclusion was directed by the CIT (A) solely for a reason of abnormal profits. Such directions were given considering the fact that such profits arose out of an extraordinary event of amalgamation - thus appeal of revenue stands dismissed Selection of comparables by applying the turnover filter - Held that - We cannot say that turnover is having no relevance especially when the assessee was having a turnover below 10 crores and was being compared with entities having turnover well exceeding 200 crores. We are therefore convinced that CIT (A) was justified in direction exclusion of companies having turnover in excess of 200 crores from the list of comparables - appeal of revenue stands dismissed Liable for a standard deduction of 5% applying proviso to Section 92C(2) - Held that - AR fairly conceded that the proviso to Sub-section (2) of Section 92C of the Act could not be considered as a standard deduction. We therefore allow ground taken by the Revenue. Assessee is an off-shore development centre had international transactions with its AE during the relevant previous year in the software development segment thus companies functionally dissimilar with that of assessee need to be deselected from final list

Issues Involved:

1. Exclusion of certain comparable companies due to abnormal profits and amalgamation.
2. Application of the turnover filter for excluding comparable companies.
3. Standard deduction under proviso to Section 92C(2) of the Act.
4. Exclusion and inclusion of specific comparables and risk adjustments.

Detailed Analysis:

1. Exclusion of Comparable Companies Due to Abnormal Profits and Amalgamation:

The Revenue challenged the CIT(A)'s decision to exclude Exensys Software Solutions Ltd. as a comparable due to its abnormal profits resulting from an amalgamation. The Tribunal upheld the CIT(A)'s decision, noting that the exclusion was justified not solely due to high profits but because the profits were a result of an extraordinary event (amalgamation with Holool India Ltd.). The Tribunal emphasized that segmental results were unavailable, further justifying the exclusion.

2. Application of Turnover Filter for Excluding Comparable Companies:

The Revenue contended against the exclusion of Infosys Technologies, iGate Global Solution Ltd., Flextronics Software & Systems Ltd., and L&T Infotech Ltd. based on the turnover filter. The CIT(A) excluded these companies as the assessee's turnover was only Rs. 9.77 crores, and these companies had turnovers exceeding Rs. 200 crores. The Tribunal upheld this decision, citing the principle that companies with significantly higher turnovers are not comparable to those with much lower turnovers. It referenced the Bombay High Court's decision in Pentair Water India (P.) Ltd., which supported the turnover filter.

3. Standard Deduction Under Proviso to Section 92C(2) of the Act:

The Revenue argued that the assessee was not entitled to a standard deduction of 5% under the proviso to Section 92C(2). The assessee conceded this point, and the Tribunal allowed this ground in favor of the Revenue.

4. Exclusion and Inclusion of Specific Comparables and Risk Adjustments:

- Exclusion of Bodhtree Consulting Ltd.: The Tribunal directed the exclusion of Bodhtree Consulting Ltd., referencing a coordinate bench decision in Kodiak Networks India (P.) Ltd., which found that Bodhtree's revenue recognition method led to erratic margins, making it an unsuitable comparable.

- Exclusion of Sankhya Infotech Ltd.: The Tribunal excluded Sankhya Infotech Ltd., noting its involvement in both software products and services without segmental information, making it incomparable.

- Exclusion of Foursoft Ltd.: The Tribunal excluded Foursoft Ltd. due to its high RPT (Related Party Transactions) of 19.89%, exceeding the acceptable threshold of 15%.

- Exclusion of Thirdware Solution Ltd.: The Tribunal excluded Thirdware Solution Ltd., as it was involved in product development without segmental details, making it functionally dissimilar.

- Exclusion of Geometric Software Solutions Co. Ltd.: The Tribunal remanded the issue back to the AO/TPO to examine the functional dissimilarity claim, as it was not previously addressed.

- Exclusion of Tata Elxsi (seg): The Tribunal excluded Tata Elxsi (seg), following the decision in Kodiak Networks India (P.) Ltd., which found it functionally different from the assessee.

- Exclusion of Sathyam Computers Service Ltd.: The Tribunal excluded Sathyam Computers Service Ltd. due to unreliable financial statements, as supported by previous Tribunal and High Court decisions.

Inclusion of New Comparables:

The assessee sought the inclusion of new comparables, which the CIT(A) had not considered. The Tribunal allowed this request, citing the evolving nature of TP (Transfer Pricing) studies, and directed the TPO to consider the new set of comparables. The TPO was also granted the freedom to select fresh comparables, except those specifically directed for exclusion.

Risk Adjustment:

The assessee's plea for risk adjustment due to underutilization of capacity was rejected. The Tribunal agreed with the TPO's findings that the assessee did not bear significant risk compared to the comparables and failed to provide a scientific quantification for the risk adjustment.

Conclusion:

The Tribunal's decision resulted in partial relief for both the Revenue and the assessee, with directions for further analysis and re-evaluation of certain comparables by the TPO. The appeals were treated as partly allowed for statistical purposes.

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