2016 (5) TMI 1498 - AT - Income Tax

TP Adjustment - comparable selection - functional similarity - application of turnover limit of 200 crores - HELD THAT - Assessee engaged in providing software development services design and support primarily developing software and providing support to its principal. Turnover of Tata Elxsi Ltd was 378.43 crores that of Sasken Communication Technologies Ltd came to 405.31 crores that of Persistent Systems Ltd was 519.69 crores that of Zylog Systems Ltd was 734.9 crores that of Mindtree Ltd (seg) was 793.22 crores that of L T Infotech Ltd was 1, 950.83 crores and that of Infosys Ltd was 20, 264 crores. Turnover of the assessee was only 22.72 crores. Obviously the volume of activity of the above mentioned companies were much higher to that of the assessee. It was more than ten times that of the assessee. Even if we say that applying turnover limit of 200 crores may not be a wise and prudent one the turnover of the comparables mentioned above would clearly show that these were much beyond that of the assessee taking them out of the reasonable realm of comparability. Just because the matter was not adjudicated by the CIT (A) may not be a reason for sending it back to him when the facts are clearly on record. There can be no dispute on the position of facts as mentioned above. In such a situation it would be fruitless exercise to remit the issue of application of turnover filter back to the CIT (A). We therefore direct exclusion of Tata Elxsi Ltd Sasken Communication Technologies Ltd (seg) Persistent Systems Ltd Zylog Systems Ltd Mindtree Ltd (seg) L T Infotech Ltd and Infosys Ltd from the list of comparables. Bodhtree Consulting Ltd . cannot be regarded as a comparable. In this regards the fact that the assessee had itself proposed this company as comparable in our opinion should not be the basis on which the said company should be retained as a comparable when factually it is shown that the said company is a software product company and not a software development services company CG-VAK can be considered as a good comparable as if all the employee costs are properly considered then this company can pass the filter applied by the TPO for excluding it. Working of operating margin of the comparables - HELD THAT - Foreign exchange adjustment once allowed as operational in nature should also be considered while working out the operating margin of the comparables is acceptable - This is because comparability should be done based on equal footing and if foreign exchange gains / losses are considered as part of operational income / loss of the assessee then such items of expenditure are also to be considered as operational in nature in the case of comparables also. TPO is therefore directed to work out the margin of the comparables that are left in the list after considering foreign exchange gains / losses as operational in nature. Working capital adjustment - HELD THAT - Working capital adjustment has been made at (-) 5, 12% . In such a situation we cannot say that risk adjustment directed by the CIT (A) was incorrect. TPO having not restricted himself to a working capital adjustment of 1.71% as mentioned by him at para 3.7 of his order ought have considered assessee s plea for a risk-adjustment if found reasonable. In such circumstances we find that direction given by the CIT (A) was justified and we do not find any reason to interfere. Ground of the Revenue stands dismissed. Operating revenue computation - inclusion of Forex gain / loss incidental to the operating activity of the assessee - HELD THAT - Just because it was not critical to the operating activity we cannot say that these had to be excluded. This Tribunal in the case of Triology E Business Software India P. Ltd v. DCIT 2013 (1) TMI 672 - ITAT BANGALORE had held that forex gains / loss are required to be added to the operating revenue relying on another coordinate bench decision in SAP Labs India (P) Ltd 2010 (8) TMI 676 - ITAT BANGALORE . We therefore do not find any error in the directions given by the CIT (A) Decided against revenue

Summary

Issues Involved:

1. Selection of comparables for Transfer Pricing (TP) study.
2. Application of turnover filter for comparables.
3. Risk adjustment in Transfer Pricing.
4. Consideration of foreign exchange gains/losses as operational in nature.
5. Exclusion of items from total turnover for Section 10A deduction.

Detailed Analysis:

1. Selection of Comparables for Transfer Pricing Study:

The assessee, engaged in software development services, had selected 21 comparables to justify its profit margin of 11.63%. The TPO rejected most of these comparables, accepting only a few and adding new ones, resulting in a higher mean margin of 24.32%. The TPO’s final list included companies like Tata Elxsi Ltd, Sasken Communication Technologies Ltd, Persistent Systems Ltd, Zylog Systems Ltd, Mindtree Ltd, L&T Infotech Ltd, and Infosys Ltd, which had significantly higher turnovers than the assessee.

2. Application of Turnover Filter for Comparables:

The assessee argued for the application of a turnover filter, citing that companies with turnovers exceeding ?200 crores should be excluded from the comparables list. The Tribunal agreed with the assessee, stating that companies with significantly higher turnovers are not comparable to the assessee, whose turnover was only ?22.71 crores. The Tribunal directed the exclusion of Tata Elxsi Ltd, Sasken Communication Technologies Ltd, Persistent Systems Ltd, Zylog Systems Ltd, Mindtree Ltd, L&T Infotech Ltd, and Infosys Ltd from the list of comparables. The Tribunal also directed the inclusion of CG-VAK Software & Exports Ltd as a comparable.

3. Risk Adjustment in Transfer Pricing:

The CIT(A) had directed the TPO to provide a risk adjustment to the assessee based on prevailing norms. The Tribunal upheld this direction, noting that the TPO had not properly considered the working capital adjustment and had not given a risk adjustment despite the assessee’s request.

4. Consideration of Foreign Exchange Gains/Losses as Operational in Nature:

The CIT(A) had considered foreign exchange gains/losses as operational in nature. The Tribunal agreed, stating that if such gains/losses are considered operational for the assessee, they should also be considered operational for the comparables. The TPO was directed to work out the margins of the comparables after considering foreign exchange gains/losses as operational.

5. Exclusion of Items from Total Turnover for Section 10A Deduction:

The CIT(A) had directed the AO to exclude from total turnover the items that were excluded from export turnover while working out the deduction under Section 10A. The Tribunal upheld this direction, following the judgment of the Hon’ble jurisdictional High Court in CIT v. Tata Elxsi Ltd, which mandates such exclusions.

Conclusion:

The appeal of the assessee was partly allowed, and the appeal of the Revenue was dismissed. The Tribunal directed the exclusion of certain high-turnover companies from the comparables list, upheld the CIT(A)’s directions on risk adjustment and foreign exchange gains/losses, and confirmed the exclusion of certain items from total turnover for Section 10A deduction.