2018 (9) TMI 1978 - AT - Income Tax

TP Adjustment - comparable selection - Functional similarity - HELD THAT - Assessee-company is engaged in the business of export of software development and IT enabled services. Acropetal Technologies Limited - segmental information containing the break-up of its export sales and employee costs, was not available and it was not possible to ascertain if it passed the export earnings and/or employee costs filters; and (ii) a substantial portion of its software development activities have been outsourced on sub contract and it could, therefore, not be retained as a comparable - As rightly held by the DRP to be not comparable. We are of the view that once a company becomes not comparable for the reason that segmental information to apply filters, we need not consider any other aspect of comparability. L T InfoTech Ltd - This company goes out of comparability on the ground that the profit margins adopted by the TPO was from 3 divisions of the Assessee - this company was held to be functionally not comparable as it is a market leader and thus enjoys significant benefits on account of ownership of marketing intangibles and intellectual property rights. Also, in addition to the above, the company owns proprietary software products which are developed in-house. Accordingly, as the company is a product company having significant intangibles and is thus not comparable to captive software service providers such as the Assessee. E-Infochips Ltd. company - It is functionally different from the profile of the assessee-company as it is engaged in development of maintenance of computer software and software development consulting and also manufacturing EVM and VDB electronic board. As per the website of the company, it provides silicon engineering evolving ASIC and FVGA design, verification and validation, physical design and DFD. Further, the company is engaged in manufacturing activities as evident from income statement. It has items pertaining to consumption of materials, changes in inventory and manufacturing service cost. It also fails service revenue filter as its software development filter is 73.78% which is less than 75% to the total revenue thereby failing the service revenue filter applied by the TPO. RS Software (India) Ltd. - Since, the entire operations of taxpayers are taking place offshore i.e in India, it is but natural that it should be compared with companies with major operations offshore, due to the reason that economics and profitability of onsite operations are different from that of offshore business model. We find that though the assessee as well as TPO has selected this company as comparable, the DRP on its own excluded this company by applying onsite revenue filter. Since, assessee as well as the revenue wants to include this company as comparable, we direct the A.O to include RS Software (India) Ltd as comparable company. Comparable for ITeS Segment - exclude M/s iGate Global Solutions Ltd, from the list of comparables on the ground that segmental information is not available - We find that though the company is deriving revenue from two different segments, it has failed to report segmental information in its annual reports. Therefore, we are of the considered view that the DRP was right in rejecting iGate Global Solutions Ltd., as comparable. We do not find any error in the findings of the DRP. Hence we are inclined to upheld findings of the DRP and reject the ground taken by the Revenue. Deduction u/s 10A - exclusion of telecommunication expenses from export turnover as well as total turnover for the purpose of determination of income eligible for deduction - HELD THAT - we find that the issue of exclusion of telecommunication expenses from export turnover needs to be excluded from total turnover or not has been decided in the case of TATA Elexi Ltd. 2011 (8) TMI 782 - KARNATAKA HIGH COURT and held that expenses excluded from export turnover have to be excluded from total turnover also, otherwise any other interpretation makes the formula unworkable and obsured and hence such deduction shall be allowed from the total turnover in same proportion as well. - DRP is right in directing the A.O to exclude expenses deducted from export turnover from total turnover. We do not find any error in the findings of the DRP, hence we are inclined to upheld the DRP findings and reject the ground raised by the Revenue. Disallowance of expenses incurred in relation to exempt income u/s 14A - HELD THAT - We find that the ITAT has considered the issue of disallowance of expenses incurred in relation to exempt income in the light of the fact that the assessee has not earned any dividend income for the year under consideration and by following the decision of Hon'ble Delhi High Court in the case of Cheminvest Ltd. v. CIT 2015 (9) TMI 238 - DELHI HIGH COURT held that disallowances contemplated u/s 14A has no application, if no exempt income is received or receivable in the relevant previous year. Thus we direct the A.O to delete the additions made towards disallowance of expenses incurred in relation to exempt income u/s 14A.

Summary

Issues Involved:

1. Exclusion of certain companies as comparables for Transfer Pricing (TP) purposes.
2. Application of onsite revenue filter.
3. Requirement of exact comparability under TNMM method.
4. Rejection of companies based on service income filter.
5. Exclusion of companies due to lack of segmental information.
6. Re-computation of income eligible for deduction under section 10A.
7. Disallowance of expenses under section 14A.

Issue-wise Detailed Analysis:

1. Exclusion of Certain Companies as Comparables for Transfer Pricing Purposes:

The Revenue challenged the exclusion of companies like Acropetal Technologies Ltd., L&T Infotech Ltd., and E-infochips Ltd. The Dispute Resolution Panel (DRP) excluded these companies due to reasons such as significant onsite activities, lack of segmental information, and functional dissimilarity. The Tribunal upheld the DRP's decision, citing that these companies do not match the functional profile of the assessee, which is a captive service provider. Specifically, Acropetal Technologies Ltd. was excluded due to predominant onsite activities and lack of clear segmental information. L&T Infotech Ltd. was excluded for similar reasons, along with its diverse revenue segments. E-infochips Ltd. was excluded due to fluctuating revenue, failure in service revenue filter, and lack of segmental information.

2. Application of Onsite Revenue Filter:

The Revenue argued against the selective application of the onsite revenue filter by the DRP. The Tribunal noted that the DRP excluded certain companies not solely based on the onsite revenue filter but also due to other significant reasons such as functional dissimilarity and lack of segmental information. The Tribunal upheld the DRP's decision, emphasizing that the economic and profitability aspects of onsite operations are different from offshore operations, which justifies the exclusion of such companies.

3. Requirement of Exact Comparability under TNMM Method:

The Revenue contended that the DRP erred in seeking exact comparability under the Transactional Net Margin Method (TNMM). The Tribunal supported the DRP's approach, stating that the selected comparables must closely match the functional profile of the assessee to ensure accurate determination of the arm's length price.

4. Rejection of Companies Based on Service Income Filter:

The DRP excluded companies like E-infochips Ltd. due to failure in the service income filter, where the company's software development revenue was less than 75% of its total revenue. The Tribunal agreed with the DRP, noting that the service income filter is crucial for ensuring comparability and that the exclusion was justified based on the company's revenue composition.

5. Exclusion of Companies Due to Lack of Segmental Information:

The DRP excluded companies like iGate Global Solutions Ltd. due to the absence of segmental information, which is necessary for accurate comparability. The Tribunal upheld this decision, emphasizing that without segmental data, it is impossible to determine if the company meets the required filters and functional comparability criteria.

6. Re-computation of Income Eligible for Deduction under Section 10A:

The DRP directed the Assessing Officer (AO) to exclude telecommunication expenses from both export turnover and total turnover for computing the deduction under section 10A. The Tribunal upheld this direction, citing the Karnataka High Court's decision in Tata Elxsi Ltd., which mandates the exclusion of such expenses from both turnovers to ensure a fair computation of the deduction.

7. Disallowance of Expenses under Section 14A:

The AO disallowed expenses under section 14A related to investments capable of earning exempt income. The assessee argued that no exempt income was earned during the year, making the disallowance inapplicable. The Tribunal agreed with the assessee, referencing previous decisions that section 14A does not apply if no exempt income is received or receivable during the relevant year. The Tribunal directed the AO to delete the disallowance.

Conclusion:

The Tribunal upheld the DRP's decisions on excluding certain companies from the list of comparables, applying the onsite revenue filter, and re-computing income eligible for deduction under section 10A. The Tribunal also directed the deletion of disallowance under section 14A, affirming that it does not apply in the absence of exempt income. The appeal filed by the Revenue was dismissed, and the cross-objection filed by the assessee was partly allowed.