2017 (1) TMI 1631 - AT - Income Tax

TPA - Comparable selection - Held that - Companies functionally dissimilar with that of assessee need to be deselected from final list. We find that if the five comparables objected to by the assessee are taken out of the list of comparables and four comparables namely Infosys, Satyam, Sankhay and Geometric are excluded from the list, the margin would be 14. 70%. The margin shown by the assessee is 15. 41% for the year under consideration. Therefore, we hold that the transaction entered into by it was at arm s length. Accordingly, reversing the order of the FAA, we hold that out of the final list of comparables five comparables, namely ESSL, Thirdware Solutions Ltd. , Foursoft, Flextronics Ltd. and Compulink System Ltd. have to be excluded. We also hold that the FAA had rightly excluded four comparable i. e. Infosys Technologies Ltd. and Satyam Computer Services Ltd. , Sankhya Infotech Ltd. and Geometric Software Solutions from the final list of valid comparables. Accordingly, effective ground of appeal, raised by the assessee with regard to comparables is allowed and ground raised by the AO, against the order of the FAA about excluding four comparables, is dismissed. Disallowance of bad debts - Held that - We find that incurring of expenditure by the assessee is not in doubt. If it cannot be allowed as bad debts it has to be allowed as business loss. Enhancement on account of change in method of accounting - Held that - The receipt of income as well as accrual took place as soon as the sale proceeds of software were received and not when the life span of software would come to an end. Therefore, spreading the income over the licence-period of the software, in our opinion, was not justified. The agreement was for up-gradation and improvisation of software - it was not warranty. Even in the matter of warranty, after the case of Rotork Controls India P. Ltd. 2009 (5) TMI 16 - SUPREME COURT OF INDIA things have become very clear-it talks of historical trend. During the course of hearing before us. the assessee had not given any indication about the expenditure incurred by it for improving and upgrading the software during the remaining period of licence. In short, the argument of matching the revenue v/s. cost is missing. lt our opinion, the method adopted by it would fall in the category which tends to distort the picture for the purpose of taxable income of the assessee - Decided against the assessee. Payment of royalty by the assessee to its AE - Held that - Merely because the royalty payments, were relating to the product sold by the Appellant to its clients for which payment could not be recovered cannot be the consideration before the TPO for determining the arm s length price of international transaction. bad debts written off cannot be factor to determine the arm s length price of any international transaction. In our opinion, TPO has exceeded his limitation by following the method which is not authorized under the Act or rules. We, therefore, hold that Arms Length Price determined by the TP adopted by the Assessing Officer to the extent of royalty payable to the Ca Inc Management, USA is not as per the procedure prescribed and same cannot be sustained. - decided against revenue.

Summary

Issues Involved:
1. Acceptance of comparables/segments for Transfer Pricing.
2. Disallowance of bad debts.
3. Enhancement due to change in method of accounting.
4. Payment of royalty to Associated Enterprises (AE).

Detailed Analysis:

1. Acceptance of Comparables/Segments for Transfer Pricing:
The primary issue revolves around the selection of comparables for determining the Arm's Length Price (ALP) of international transactions. The assessee and the Assessing Officer (AO) filed cross-appeals regarding the inclusion and exclusion of certain comparables. The Transfer Pricing Officer (TPO) had identified 19 comparables, and the First Appellate Authority (FAA) excluded four of them (Infosys, Satyam Computer Services Ltd., Geometric Software Solutions Co. Ltd., and Sankhya Infotech Ltd.) while retaining 15. The assessee contested the inclusion of five comparables (Exensys Software Solutions Ltd., Thirdware Solutions Ltd., Foursoft Ltd., Flextronics Software Solutions Ltd., and Compulink Systems Ltd.), arguing they were functionally dissimilar and engaged in different business activities. The Tribunal agreed with the assessee, excluding these five comparables and upholding the exclusion of the four comparables by the FAA. Consequently, the Tribunal concluded that the transactions were at arm's length, reversing the FAA's order regarding the inclusion of the five contested comparables.

2. Disallowance of Bad Debts:
The AO disallowed bad debts amounting to ?8.74 lakhs, questioning their validity since the debts were from cash-rich companies. The FAA allowed the bad debts claim but disallowed the ?8.74 lakhs related to non-receipt of C-Forms. The Tribunal, referencing the case of Harshad J. Choksi, held that if the expenditure could not be allowed as bad debts, it should be allowed as a business loss. Thus, the Tribunal decided in favor of the assessee on this issue.

3. Enhancement Due to Change in Method of Accounting:
The assessee changed its method of accounting for software license sales, deferring revenue recognition over the contract period, which the AO and FAA rejected. The Tribunal reviewed the case and previous judgments, concluding that the change in accounting method was not justified as it lacked evidence of incurred expenses for software updates and services. The Tribunal upheld the FAA's decision, rejecting the assessee's claim for the change in accounting method.

4. Payment of Royalty to Associated Enterprises (AE):
The AO made an adjustment of ?15.88 lakhs for royalty payments to the AE, which the FAA overturned based on the Tribunal's decisions for previous years. The Tribunal upheld the FAA's decision, stating that bad debts written off could not factor into determining the ALP of international transactions. The Tribunal directed the AO to adopt the ALP of royalty payments as declared by the assessee, thus ruling in favor of the assessee.

Conclusion:
The Tribunal allowed the assessee's appeal regarding the comparables and bad debts issues, while dismissing the AO's appeal on the exclusion of comparables and royalty payment adjustments. The Tribunal upheld the FAA's decision on the change in the method of accounting, ruling against the assessee.