2016 (9) TMI 1458 - AT - Income Tax

Arm s Length Price of software development services to the AE - comparable selection - sub-contracting charges being part of operating cost as well as corresponding revenue from AE for the purpose of operating income - Held that - It is pertinent to note that outsourcing cost in software development services activity is part and parcel of cost of providing the service to the AE and cannot be separated from the operating cost and operating revenue of the said segment of services. Accordingly the cost of software development services cannot be treated in this fashion as claimed by the assessee. Hence we do not find any merit or substance in the contention raised by the assessee on this issue. As regards the alternative plea raised by the AR that the comparables should also have similar activity we find that the TPO has applied a filter of cost of employee which subsumes the outsourcing activity of both assessee as well as the comparables. Accordingly the issue is decided against the assessee. Companies functionally dissimilar with that of assessee need to be deselected from final list. Companies with export revenue less than 75% applied by the TPO need to be deselected. Exclusion of sub-contracting charges from export turnover while computing deduction under Section 10A - Held that - As in the case of Tata Elxsi Ltd vs. ACIT 1980 (4) TMI 12 - PUNJAB AND HARYANA HIGH COURT expenses reduced from the export turnover ought to be reduced from the total turnover as well. Exclusion of forex loss from export turnover while computing the deduction under Section 10A - Held that - It is pertinent to note that the turnover is considered on mercantile basis and not on realization basis. Therefore any loss on account of fluctuation of forex rate would be a business loss and should have effect of reduction of profits and corresponding eligible profits for deduction under Section 10A - Such loss cannot be reduced from export turnover based on the invoices and the loss on realization is a business loss not affecting the turnover. Therefore we direct the Assessing Officer to recompute the deduction under Section 10A by considering the profit after loss on Forex fluctuations on realization and not by reducing the export turnover. In any case if the loss is excluded from export turnover then the corresponding total turnover should also be reduced by such amount as per the decision of the Hon ble jurisdictional High Court in the case of Tata Elxsi Ltd.

Issues Involved:

1. Arm’s Length Price (ALP) determination for software development services.
2. Exclusion of expenses incurred in foreign currency while computing deduction under Section 10A of the Income Tax Act.
3. Inclusion and exclusion of certain comparable companies in Transfer Pricing (TP) analysis.
4. Treatment of sub-contracting charges as pass-through costs.
5. Jurisdictional and procedural issues raised by the assessee regarding the orders of the Assessing Officer (AO) and Transfer Pricing Officer (TPO).
6. Treatment of forex loss in the computation of export turnover.

Detailed Analysis:

1. Arm’s Length Price (ALP) Determination for Software Development Services:

The primary dispute revolves around the ALP of software development services provided to the Associated Enterprise (AE). The assessee claimed an operating profit margin of 11.42% and selected 10 comparable companies, resulting in an arithmetic mean of 14.31%. The TPO rejected six of these comparables and added nine new ones, calculating an adjusted average PLI of 24.77%, leading to a proposed adjustment of ?23,41,94,490 under Section 92CA of the Act. The assessee challenged this, and the Dispute Resolution Panel (DRP) rejected nine of the TPO's comparables, leaving four. Both parties filed cross-appeals.

2. Exclusion of Expenses Incurred in Foreign Currency While Computing Deduction Under Section 10A:

The assessee argued that sub-contracting charges and travel expenses incurred in foreign currency should not be reduced from the export turnover for computing deductions under Section 10A. The DRP allowed the exclusion of travel expenses but not sub-contracting charges. The Tribunal directed that if sub-contracting charges are reduced from export turnover, they should also be reduced from total turnover, following the Karnataka High Court's decision in Tata Elxsi Ltd.

3. Inclusion and Exclusion of Certain Comparable Companies in TP Analysis:

The Tribunal addressed the comparability of several companies:

- E-Zest Solutions Ltd., Persistent Systems and Solutions Ltd., Persistent Systems Ltd., Sasken Communication Technologies Ltd.: The Tribunal found these companies functionally dissimilar to the assessee and directed their exclusion.
- Akshay Software Technology Ltd., LGS Global Ltd.: The Tribunal upheld the rejection of Akshay Software Technology Ltd. due to lack of functional comparability and set aside the issue of LGS Global Ltd. for further verification of employee costs.
- Evoke Technology Ltd., R S Software (India) Ltd.: Both parties sought inclusion of these companies, and the Tribunal directed their inclusion in the final set of comparables.
- Acropetal Technologies Ltd., ICRA Techno Analytics Ltd., Infosys Ltd., L&T Infotech Ltd., Tata Elxsi Ltd.: The Tribunal upheld the DRP's rejection of these companies based on various functional dissimilarities and filters applied.

4. Treatment of Sub-Contracting Charges as Pass-Through Costs:

The assessee contended that sub-contracting charges should be treated as pass-through costs and excluded from operating profit and cost. The Tribunal rejected this, stating that the assessee provides software development services with a markup and is not merely an agent. Therefore, sub-contracting charges are part of the operating cost and revenue.

5. Jurisdictional and Procedural Issues Raised by the Assessee:

The assessee raised several procedural and jurisdictional issues, including the lack of a show-cause notice under Section 92C(3) and the validity of the TPO's order. The Tribunal did not find merit in these contentions and upheld the actions of the AO and TPO.

6. Treatment of Forex Loss in the Computation of Export Turnover:

The Tribunal directed that forex loss should not be reduced from the export turnover but should be considered a business loss affecting the profit computation. If forex loss is excluded from export turnover, it should also be excluded from total turnover, following the Tata Elxsi Ltd. decision.

Conclusion:

The Tribunal partly allowed both the assessee's and the revenue's appeals, directing recomputation of the ALP and deductions under Section 10A based on the final set of comparables and the principles laid down in the judgment.

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