2017 (5) TMI 1700 - AT - Income Tax

TP Adjustment - Comparable selection - functional dissimilarity - HELD THAT - Companies functionally dissimilar cannot be compared with assessee-company which is engaged in IT enabled services. We direct the AO/TPO to consider only profit margin of the software segment for the purpose of computing while arm s length price of the transaction. RPT filer of 15% - TPO has applied RPT filter of 25%. The learned AR has not challenged the applicability of this filter. Therefore we hold that Company failing to meet the filter set be excluded from the list of comparables.

Issues Involved
1. Assessment and reference to Transfer Pricing Officer (TPO).
2. Fresh comparable search by TPO.
3. Comparability analysis for software development services.
4. Comparability analysis for IT support services.
5. Erroneous data used by AO/TPO.
6. Non-allowance of appropriate adjustments.
7. Variation of 5% from the arithmetic mean.
8. Incorrect determination of arm's length price.
9. Reduction in deduction under section 10A and 10B.
10. Disallowance of deduction under section 10A and 10B for on-site work by AEs.
11. Disallowance of deduction under section 10A for STP units of merged entity.
12. Interest under section 234B.
13. Interest under section 234C.
14. Penalty under section 271(l)(c).
15. Directions issued by DRP.
16. Relief sought by the appellant.

Detailed Analysis

1. Assessment and reference to Transfer Pricing Officer (TPO)
The assessee-company challenged the assessment order and the reference to the TPO, claiming it was bad in law and violated principles of natural justice. The AO did not issue a show-cause notice as per proviso to section 92C(3) of the Income-tax Act, 1961. The AO also failed to record an opinion that conditions in section 92C(3) were satisfied, and did not follow section 92CA(1).

2. Fresh comparable search by TPO
The TPO conducted a fresh benchmarking analysis using non-contemporaneous data, substituting the appellant's analysis. The TPO did not demonstrate the appellant's motive to shift profits outside India by manipulating prices in international transactions, a prerequisite for adjustments under Chapter X.

3. Comparability analysis for software development services
The AO/TPO rejected the assessee's comparable companies without considering the functional and risk analysis. Arbitrary filters were applied to arrive at new comparables, deviating from the Income-tax Rules, 1963. Companies were arbitrarily rejected based on different year-ends, employee costs, export revenues, onsite revenues, and software development revenues. Secret data under section 133(6) was also used unjustifiably.

4. Comparability analysis for IT support services
Similar issues as in software development services were raised. The AO/TPO rejected the appellant's comparables without functional analysis, applied arbitrary filters, and used secret data unjustifiably.

5. Erroneous data used by AO/TPO
The AO/TPO used non-contemporaneous data not available in the public domain at the time of the transfer pricing study. Multiple-year data was not applied while computing the margin of comparable companies.

6. Non-allowance of appropriate adjustments
The AO/TPO did not allow appropriate adjustments under Rule 10B to account for differences in accounting practices between the appellant and comparable companies.

7. Variation of 5% from the arithmetic mean
The AO/TPO did not grant the benefits of the proviso to section 92C(2) available to the appellant.

8. Incorrect determination of arm's length price
The AO/TPO used enterprise-wide segmental margins to determine the related party cost, not considering the cost break-up for related and unrelated transactions.

9. Reduction in deduction under section 10A and 10B
The AO reduced travel and telecommunication expenses from export turnover while computing deductions under sections 10A and 10B, ignoring the appellant's claim that it was engaged in software development, not technical services. The AO also failed to reduce these expenses from total turnover.

10. Disallowance of deduction under section 10A and 10B for on-site work by AEs
The AO disallowed deductions for on-site work performed by AEs overseas, amounting to significant disallowances under sections 10A and 10B.

11. Disallowance of deduction under section 10A for STP units of merged entity
The AO denied deductions under section 10A for STP units of the merged entity, concluding that earlier claims under section 80HHE for non-STP units disqualified the appellant from section 10A deductions for STP units. The AO disregarded favorable orders from the Delhi Tribunal in the appellant's own case.

12. Interest under section 234B
The AO levied interest under section 234B amounting to ?274,261,676.

13. Interest under section 234C
The AO levied interest under section 234C amounting to ?1,168,725.

14. Penalty under section 271(l)(c)
The AO initiated penalty proceedings under section 271(l)(c).

15. Directions issued by DRP
The DRP did not consider the appellant's objections to the draft assessment and TP orders, confirming the AO's draft order.

16. Relief sought by the appellant
The appellant sought relief from the above grounds and consequential reliefs, including deletion of transfer pricing adjustments made by the AO/TPO and upheld by the DRP.

Conclusion
The Tribunal addressed each issue segment-wise, particularly focusing on the comparability analysis for IT support and software development services. Several companies were excluded from the list of comparables due to functional dissimilarity, failure to meet employee cost filters, RPT filters, and unreliable financial results. The Tribunal also directed adjustments for appropriate comparables and upheld the appellant's claims for deductions under sections 10A and 10B, following jurisdictional High Court decisions. The appeal was partly allowed, providing relief on various grounds.

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