2017 (2) TMI 1383 - AT - Income Tax

Computing the deduction u/s 10A - Held that - This issue is covered in favour of the assessee by the judgment of Hon ble Karnataka High Court rendered in the case of Tata Elxsi Ltd. 2011 (8) TMI 782 - KARNATAKA HIGH COURT wherein it was held that Total Turnover is sum total of Export Turnover and Domestic Turnover and therefore if an amount is reduced from export turnover then total turnover also goes down by the same amount automatically. Not considering foreign exchange gain / loss as operating income / operating expense while calculating the net cost-plus margins of the Appellant and comparable companies as per directions issued by the Ld. Panel - Held that - It cannot be considered if it arises in respect of the turnover of an earlier year because we are concerned with the operating profit of the current year for working out assessee s margin of profit to compare with the margin of profit of the comparables and since the related turnover is not included in the turnover taken in the denominator if the Exchange Fluctuation Gain is not excluded from the numerator it will result in absurd result. We therefore restore this matter to AO/TPO for a fresh decision with the direction that if the related turnover from which the Exchange Fluctuation Gain has arisen is the turnover of the current year then the Exchange Fluctuation Gain should be considered as operating profit of the current year for working out the percentage of profit of the assessee for current year to compare it with rate of profit of the comparables but if it is in respect of the turnover of an earlier year then such Exchange Fluctuation Gain should be excluded from operating profit of the current year for working out the percentage of profit of the assessee for current year. Comparable selection - Held that - Companies functionally dissimilar with that of assessee need to be deselected from final list. Exclusion on account of RPT filter confirmed.

Issues Involved:
1. Legality of Assessment and Reference to Transfer Pricing Officer (TPO)
2. Computation of Transfer Pricing Adjustment
3. Determination of Arm's Length Price (ALP) for Software Development Services
4. Use of Non-contemporaneous Data by AO/TPO
5. Non-allowance of Appropriate Adjustments to Comparable Companies
6. Variation of 5% from Arithmetic Mean
7. Deduction under Section 10A of the Income-tax Act, 1961
8. Directions Issued by the Dispute Resolution Panel (DRP)
9. Penalty Proceedings

Detailed Analysis:

1. Legality of Assessment and Reference to Transfer Pricing Officer (TPO):
The assessee contended that the assessment order by the AO under section 143(3) read with section 144C of the Income-tax Act, 1961, was bad in law and violated the principles of natural justice. The AO failed to issue a show-cause notice as required by Section 92C(3) of the Act. The DRP did not consider the objections raised by the assessee regarding transfer pricing matters. The DRP arbitrarily rejected certain comparables without issuing a show-cause notice and did not demonstrate that the appellant's motive was to shift profits outside India.

2. Computation of Transfer Pricing Adjustment:
The AO incorrectly computed the transfer pricing adjustment at INR 33,050,970. The AO/TPO did not consider foreign exchange gain/loss as operating income/expense while calculating the net cost-plus margins. The rectified net-cost plus margin of comparable companies retained by the DRP was also not considered.

3. Determination of Arm's Length Price (ALP) for Software Development Services:
The DRP and AO/TPO erred in rejecting the value of international transactions recorded in the books of account as the ALP. They determined a new ALP substituting the one determined by the appellant. The fresh comparability analysis using non-contemporaneous data conducted by the TPO was confirmed by the DRP. The DRP and AO/TPO benchmarked transactions with companies operating as full-fledged entrepreneurs without considering the differences in functions, assets, and risks. Arbitrary filters were applied for rejecting companies identified by the appellant, and certain comparables were incorrectly accepted without considering the appellant's turnover and size.

4. Use of Non-contemporaneous Data by AO/TPO:
The DRP and AO/TPO used data that was not contemporaneous and not available in the public domain when the transfer pricing study was conducted by the appellant. They also disregarded the application of multiple-year data while computing the margins of comparable companies.

5. Non-allowance of Appropriate Adjustments to Comparable Companies:
The AO/TPO did not allow appropriate adjustments under Rule 108 for differences in accounting practices, marketing expenditure, research and development expenditure, and risk profile between the appellant and comparable companies. The DRP and AO/TPO did not provide an opportunity to the company before making an adjustment for negative working capital.

6. Variation of 5% from Arithmetic Mean:
The AO/TPO did not grant the variation as per the proviso to Section 92C(2) of the Act.

7. Deduction under Section 10A of the Income-tax Act, 1961:
The AO reduced travel expenditure incurred in foreign currency from the export turnover while computing the deduction under section 10A, which was confirmed by the DRP. This action was contrary to the fact that the expenditure was not attributable to the delivery of computer software outside India.

8. Directions Issued by the Dispute Resolution Panel (DRP):
The DRP did not take cognizance of the objections filed by the appellant regarding the draft assessment order issued by the AO/TPO and confirmed the draft order.

9. Penalty Proceedings:
The appellant argued that there was no basis for the AO to initiate proceedings under section 274 read with section 271 of the Act.

Separate Judgments:
The tribunal held that the issue about the deduction under section 10A was covered in favor of the assessee by the judgment of the Hon’ble Karnataka High Court in the case of Tata Elxsi Ltd. (349 ITR 98). The tribunal upheld the exclusion of certain comparables as directed by the DRP and included others based on previous tribunal orders. The issue of exchange fluctuation gain was restored to the AO/TPO for fresh decision.

Conclusion:
Both the assessee's and the revenue's appeals were partly allowed. The tribunal directed the AO/TPO to recompute the ALP based on the final list of comparables, including Evoke Technologies Pvt. Ltd., Mindtree Ltd. (Seg), R S Software (India) Ltd., and LGS Global Ltd. The tribunal also restored the issue of exchange fluctuation gain to the AO/TPO for fresh consideration.

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