2016 (6) TMI 1374 - AT - Income Tax

Transfer Pricing Adjustment - assessee is engaged in the business of providing software services related to back office operations on contract basis to overseas Siemens Group companies - RPT filter at 15% - HELD THAT - In normal circumstances when there is no difficulty in selecting the comparables the RPT filter should not exceed 15% of the sale/revenue. In the case on hand the TPO has selected as many as 27 comparables which shows that there was no difficulty in finding the comparable companies and therefore we are of the considered opinion that the RPT filter shall not exceed 15% of the total sale instead of 25% filter applied by the TPO. Only in the exceptional cases where the comparable companies are not easily available and only few companies are found during the search then the tolerance range of RPT can be relaxed to the maximum limit of 25%. Since the case on hand is not an exceptional case therefore in our view the extreme limit of 25% of RPT filter cannot be applied in this case. In view of the above facts we admit the additional grounds raised by the assessee regarding the RPT filter at 15%. Application of employee cost filter at 25% - HELD THAT - We agree with the contention of the learned Authorised Representative that the employee cost filter should be applied at 25% however even if it is applied to 1 or 2% less or more will not cause any substantial effect or would be prejudicial to the interest of either of the party. We are of the view that the ITES sector is employee intensive and therefore the cost of the employees cannot be ignored for selecting the comparable companies. If in a particular case of company the employee cost is less than the average cost previaling in the industry then it is necessary to find out the reasons of such a low employee cost which is against the normal business practice in this industry. Accordingly we admit the additional ground raised by the assessee with a rider that the TPO has to apply a proper filter of employee cost and then apply the same on all the comparable companies in the set of comparables. A low employee cost shows a different business model and it appears that these companies are outsourcing their business however since the TPO has not examined this issue therefore we set aside this issue to the record of the TPO/A.O for limited purpose of verification of the reasons for such a low employee cost and if it is found that low employee cost is due to a different business model then these companies shall be excluded from the list of comparables. Software development segment cannot be compared with ITES segment and hence this company cannot be compared with the assessee s ITES segment. Assessing Officer himself has applied the employee cost filter at 25% and this company is having employee cost of 22.69%. However in the case of the assessee as we have discussed in the foregoing paras neither the assessee nor the TPO has applied any employee cost filter. While deciding the additioal ground we have set aside this issue to the record of the TPO/A.O to apply an appropriate employee cost filter. Accordingly the comparability of this company has been set aside to the record of the TPO/A.O for reconsideration and adjudication. Revenue from software products and also enjoy the benefit of huge intangible asset apart from brand value and leader in the market. Since the employee cost is only 7.16% and further the revenue form ITES is only 8.21% therefore by any yardstick this company cannot be considered as functionally comparable having a different business model of low employee cost and low revenue from the ITES segment. Accordingly we direct the A.O./TPO to verify the alleged fact and if it is found correct this company shall be excluded from the list of comparables. Since we have directed the A.O./TPO to exclude certain comparables and also re-examine certain issues therefore the ALP has to be recomputed after exclusion of the companies from the list of comparables as directed by us as well as re-examination of the comparability of certain companies. Needless to say that the benefit of the proviso to Section 92C also be considered if the ALP is within the tolerance range of or 5%. Foreign currency from the export turnover for computation of deduction under Section 10A - HELD THAT - The Hon ble Karnataka High Court in the case of CIT v M/s Tata Elxsi Ltd. Others 2011 (8) TMI 782 - KARNATAKA HIGH COURT had held that while computing the exemption u/s 10A if the export turnover in the numerator is to be arrived at after excluding certain expenses the same should also be excluded from the total turnover in the denominator - we direct the AO to exclude the above mentioned expenses both from the export turnover as well as from the total turnover while calculating deduction u/s 10A

Issues Involved:

1. Assessment and reference to Transfer Pricing Officer (TPO)
2. Comparability analysis for determination of arm's length price
3. Use of erroneous data by TPO
4. Non-allowance of appropriate adjustments
5. Mark-up on recovery transactions
6. Variation of 5% from the arithmetic mean
7. Grant of lower deduction under section 10A
8. Non-grant of carry forward of current year business losses
9. Directions issued by the Dispute Resolution Panel (DRP)
10. Initiation of penalty proceedings
11. Relief sought by the appellant

Detailed Analysis:

1. Assessment and Reference to TPO:
The appellant contended that the assessment order and reference to the TPO were bad in law, violating principles of natural justice. The AO erred by not issuing a show-cause notice as required under Section 92C(3) of the Income Tax Act. Additionally, the AO did not record an opinion that conditions under Section 92C(3) were satisfied. The TPO conducted a fresh benchmarking analysis using non-contemporaneous data, substituting the appellant's analysis based on conjectures and surmises.

2. Comparability Analysis for Determination of Arm's Length Price:
The appellant challenged the comparability analysis adopted by the TPO, arguing that the TPO erred in benchmarking transactions of the captive call center services with companies operating as full-fledged entrepreneurs. The TPO applied arbitrary filters without establishing functional comparability and inconsistently applied such filters, rejecting companies based on turnover, size, and financial results without considering comparability. The TPO also excluded foreign exchange gain or loss while calculating net margins.

3. Use of Erroneous Data by TPO:
The appellant argued that the TPO used non-contemporaneous data not available in the public domain at the time of the transfer pricing study by the appellant. The TPO did not apply multiple-year data while computing the margin of comparable companies.

4. Non-Allowance of Appropriate Adjustments:
The appellant contended that the TPO did not allow appropriate adjustments under Rule 10B to account for differences in accounting practices, marketing expenditure, and risk profile between the appellant and comparable companies.

5. Mark-up on Recovery Transactions:
The appellant argued that the TPO erred in making adjustments on the ground that the appellant should have charged a markup on pass-through transactions with associated enterprises, without considering the submissions filed by the appellant.

6. Variation of 5% from the Arithmetic Mean:
The appellant contended that the TPO did not grant the benefits of the proviso to Section 92C(2) of the Act, which allows a variation of 5% from the arithmetic mean.

7. Grant of Lower Deduction under Section 10A:
The appellant argued that the DRP and the AO erred in computing the deduction under Section 10A by reducing expenses incurred in foreign currency from the export turnover without making a corresponding reduction in the total turnover.

8. Non-Grant of Carry Forward of Current Year Business Losses:
The AO did not allow the current year business loss of ?7,720,426 to be carried forward.

9. Directions Issued by the DRP:
The appellant contended that the DRP did not take cognizance of the objections filed by the appellant regarding the draft assessment order and erred in confirming the draft order of the AO/TPO.

10. Initiation of Penalty Proceedings:
The appellant argued that there was no basis for the AO to propose initiating penalty proceedings under Section 271(1)(c) of the Act.

11. Relief Sought by the Appellant:
The appellant prayed for directions to grant relief arising from the above grounds and all consequential reliefs. The appellant also craved leave to add to or alter the grounds of appeal before or during the hearing.

Judgment:

Transfer Pricing Adjustment:
The tribunal allowed the exclusion of certain companies from the list of comparables based on functional dissimilarity, low employee cost, and other factors. The tribunal also directed the TPO to re-examine the comparability of certain companies and apply appropriate filters, including the employee cost filter at 25% and the RPT filter at 15%.

Deduction under Section 10A:
The tribunal directed the AO to exclude expenses incurred in foreign currency from both the export turnover and total turnover while calculating the deduction under Section 10A, following the principle laid down by the Hon'ble Karnataka High Court and the Hon'ble Mumbai High Court.

Carry Forward of Business Losses:
The tribunal directed the AO to verify the claim for carry forward of business losses and decide the same as per law.

Other Grounds:
Ground No.6 regarding mark-up on recovery transactions was dismissed as not pressed. Ground Nos.10 to 12 were general in nature and did not require adjudication.

Conclusion:
The appeal of the assessee was partly allowed, with directions to the AO/TPO to re-compute the ALP after excluding certain comparables and re-examining others, and to consider the benefit of the proviso to Section 92C if the ALP is within the tolerance range of +/-5%. The tribunal also directed the AO to exclude certain expenses from both export turnover and total turnover while calculating the deduction under Section 10A and to verify and allow the carry forward of business losses as per law.

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