2018 (7) TMI 1862 - AT - Income Tax

TPA - Comparable selection - Held that - Assessee rendered software development (technical support) to its AEs - Held that - The decisions cited by the learned DR before us cannot be the basis to hold that high turnover is not relevant criteria for deciding on comparability of companies in determination of ALP under the Transfer Pricing regulations under the Act. For the reasons given above we uphold the order of the CIT(A) on the issue of application of turnover filter and his action in excluding companies by following the ratio laid down in the case of Genisys Integrating (2011 (8) TMI 952 - ITAT BANGALORE). Assessee is engaged in the business of providing software development (technical support) services and marketing support services to its overseas Associated Enterprises ( AE ). Being a captive service provider the Assessee assumes less than normal risks and all significant business and entrepreneurial risks are borne by the AEs thus companies functionally deselected from final list. with that of assessee need to be deselected from final list. As uncontroverted fact regarding another company amalgamating with this company and consequent abnormal profit of this company company was rightly directed to be excluded by the CIT(A). We find no grounds to interfere with the order of CIT(A) in this regard. TPO/AO is directed to compute the ALP on the basis of directions given above and if the Assessee is found eligible for the benefit of tolerance limit as per the second proviso to Sec.92CA(2) of the Act allow the said benefit and compute ALP.

Issues Involved:
1. Determination of Arm’s Length Price (ALP) for international transactions of software development services for AY 2005-06 and AY 2008-09.
2. Application of turnover filter for exclusion of comparable companies.
3. Exclusion of companies with abnormal profit margins.
4. Functional dissimilarity of comparable companies.
5. Inclusion of foreign exchange gain/loss as part of operating profit/loss.
6. Adjustment for working capital differences.

Detailed Analysis:

1. Determination of Arm’s Length Price (ALP) for International Transactions:
The core issue in both the assessment years (AY 2005-06 and AY 2008-09) was the determination of ALP for the international transaction of providing software development services by the Assessee to its Associated Enterprises (AE). The Assessee used the Transaction Net Margin Method (TNMM) with Operating Profit to Operating Cost (OP/OC) as the Profit Level Indicator (PLI). The Transfer Pricing Officer (TPO) and the Assessing Officer (AO) made adjustments to the ALP, which were contested by the Assessee.

2. Application of Turnover Filter:
The CIT(A) applied a turnover filter to exclude companies with turnovers significantly higher than the Assessee. For AY 2005-06, companies with turnovers above Rs. 200 crores were excluded, including Flextronics Ltd., L&T Infotech Ltd., Infosys Technologies Ltd., Satyam Computer Services Ltd., and iGate Global Solutions Ltd. The Tribunal upheld this exclusion, citing the principle that size matters in business, and smaller companies cannot be compared with significantly larger ones.

3. Exclusion of Companies with Abnormal Profit Margins:
For AY 2005-06, the CIT(A) excluded Exensys Software Solutions Ltd. and Thirdware Solutions Ltd. due to their abnormal profit margins. The Tribunal agreed with the exclusion of Exensys due to an amalgamation event but reinstated Thirdware, as no extraordinary events were shown to justify its exclusion based solely on high profits.

4. Functional Dissimilarity of Comparable Companies:
The CIT(A) and the Tribunal excluded several companies on the grounds of functional dissimilarity. For AY 2005-06, Bodhtree Consulting Ltd. and Tata Elxsi Ltd. were excluded. For AY 2008-09, Avani Cincom Technologies Ltd., Kals Information Systems Ltd., Infosys Technologies Ltd., Persistent Systems Ltd., Tata Elxsi Ltd., and Wipro Ltd. were excluded for being functionally dissimilar to the Assessee. The Tribunal also excluded Celestial Biolabs Ltd. and e-Zest Solutions Ltd. for functional dissimilarity.

5. Inclusion of Foreign Exchange Gain/Loss:
The CIT(A) directed that foreign exchange gains/losses should be considered as operating profit/loss. The Tribunal upheld this direction, aligning with the decisions of the jurisdictional Bench in cases like SAP Labs India (Pvt.) Ltd. and Trilogy E-Business Software India (Pvt.) Ltd.

6. Adjustment for Working Capital Differences:
The CIT(A) and the Tribunal directed that adjustments for working capital differences should be provided to the margins of the comparable companies. This was consistent with the provisions of Rule 10B(3) of the Income Tax Rules, 1962, and supported by various decisions of the Bangalore Bench of ITAT.

Conclusion:
The Tribunal's consolidated order addressed multiple issues related to the determination of ALP for software development services provided by the Assessee to its AE. The Tribunal upheld the CIT(A)'s application of the turnover filter, exclusion of functionally dissimilar companies, and the inclusion of foreign exchange gains/losses as operating profits/losses. It also directed adjustments for working capital differences. The appeals were partly allowed for both the Assessee and the Revenue for AY 2005-06, and the Revenue's appeal for AY 2008-09 was dismissed, while the Assessee's appeal for the same year was partly allowed.

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