2019 (7) TMI 1883 - AT - Income Tax

TP adjustment - comparable selection - determination of Arm s length price (ALP) in respect of a transaction of rendering software development service by the Assessee to its Associated enterprise (AE) - excluding M/s. Flextronics Software Services Ltd. iGate Global Solution M/s. Infosys Technologies Ltd. Satyam Computers Services Ltd. and L T Infotech Ltd. on the ground that the turnover of these companies was above 200 crores and therefore the Assessee whose turnover is only 6.36 Crores cannot be compared with those companies - HELD THAT - The admitted factual position is that these companies have turnover of over 200 crores in the relevant asst. year whereas the assessee s turnover is only 6.36 crores. It has been held by the Bangalore Bench of ITAT that turnover filter is a valid filter in the matter of exclusion of comparables that companies with turnover below 200 crores cannot be compared with the companies above 200 crores. In this regard Bangalore Bench of the Tribunal in the case of Auto Desk India Pvt. Ltd. 2018 (12) TMI 1742 - ITAT BANGALORE has taken the aforesaid view after considering several decisions on the issue. In view of the above we find no grounds to interfere with the exclusion of the aforesaid 5 companies by the CIT(A). Exclusion of M/s. Exensys Software Solutions Ltd. and Thirdware Solutions Ltd. as not comparable companies by the CIT(A) on the ground that these companies showed abnormal profits - On the issue of exclusion of companies on account of abnormal profits the law is well settled that abnormal profits by itself is not a ground to exclude a company which is otherwise comparable but if the abnormal profits are owing to some unusual circumstances then those companies can be excluded. As far as exclusion of M/s. Exensys Software Solutions Ltd. is concerned the same is due to amalgamation that happened between this company and some other company during the relevant previous year and therefore the CIT(A) was justified in excluding this company. Thirdware Solutions Ltd company was a product company and not a SWD service provider such as the Assessee and this company was excluded. We are of the view that in view of the aforesaid order of the Tribunal we sustain the order of CIT(A) on the basis that this company needs to be excluded as functionally not comparable M/s. Quintegra Solutions Ltd. had a different accounting year than that of the Assessee and therefore this company ought to have been excluded by the CIT(A) and the learned counsel for the Assessee did not object to its exclusion from the list of comparable companies . Therefore ground No.5 raised by the revenue is allowed. Exclusion of the following companies Bodhtree Consulting Ltd. Geometric Software Solutions Co. Ltd. and Tata Elxsi Ltd. from the list of comparable companies - The assessee is pure software SWD service provider whereas these companies were software product companies. The exclusion of these companies in the case of pure software development service provider such as the assessee was considered by this Tribunal in the case of Kodiak Network India Pvt. Ltd 2015 (8) TMI 225 - ITAT BANGALORE AND M/S. SHARP SOFTWARE DEVELOPMENT (INDIA) PVT. LTD. AND VICE-VERSA. 2017 (1) TMI 1734 - ITAT BANGALORE - Both these cases relate to asst. year 2005-06 and in these cases it was held in that case that the aforesaid companies were software product companies and not software development service provider such as the Assessee and the segmental details of SWD services and SW Products were not available and therefore the profit margin in the SWD services segment of these companies were not available for comparison. In the light of the aforesaid decision of the Tribunal we are of the view that the exclusion of the aforesaid companies by the CIT(A) was justified. Inclusion of M/s. VJIL Consulting Ltd. as not comparable. It was agreed by the parties that this company can be treated as a comparable company and hence ground No.7 raised by the revenue is allowed. Directing working capital adjustment to be allowed - Even the TPO in his order has allowed working capital adjustment. In transfer pricing analysis allowing working capital adjustment is necessary and it is settled law that such adjustment should be made for proper comparison of profit margin of Assessee and the comparable companies. We find no merit in this ground of appeal raised by the revenue. Computation of deduction u/s 10A - HELD THAT - Taking into consideration the decision rendered by the Hon ble High Court of Karnataka in the case of CIT v. Tata Elxsi Ltd 2011 (8) TMI 782 - KARNATAKA HIGH COURT we are of the view that communication charges should be excluded both from export turnover and total turnover. We are of the view that as of today law declared by the Hon ble High Court of Karnataka which is the jurisdictional High Court is binding on us.

Summary

Issues Involved:
1. Determination of Arm's Length Price (ALP) for software development services.
2. Exclusion and inclusion of certain companies as comparables.
3. Application of turnover filter.
4. Exclusion based on abnormal profits.
5. Application of diminishing revenue filter.
6. Inclusion of companies with different accounting years.
7. Working capital adjustment.
8. Computation of deduction under Section 10A, including exclusion of telecommunication charges from export turnover and total turnover.

Detailed Analysis:

1. Determination of Arm's Length Price (ALP) for software development services:
The primary dispute revolves around the determination of ALP for the software development services provided by the Assessee to its Associated Enterprise (AE), Facetime Communications Inc., USA. The Assessee used the Transaction Net Margin Method (TNMM) as the Most Appropriate Method (MAM), which was accepted by the Transfer Pricing Officer (TPO). The TPO made an adjustment to the price charged in the international transaction, which was challenged by the Assessee before the CIT(A). The CIT(A) provided partial relief, leading to appeals by both the Revenue and the Assessee.

2. Exclusion and inclusion of certain companies as comparables:
The TPO selected 17 comparable companies, but the CIT(A) excluded some and included others. The Revenue appealed against the exclusion of companies like Flextronics Software Services Ltd., iGate Global Solutions Ltd., Infosys Technologies Ltd., L&T Infotech Ltd., and Satyam Computers Services Ltd. based on their high turnover. The Tribunal upheld the CIT(A)'s decision, citing that companies with a turnover above ?200 crores are not comparable to the Assessee with a turnover of ?6.36 crores.

3. Application of turnover filter:
The Tribunal agreed with the CIT(A) that the size and turnover of companies are deciding factors for comparability. Companies with a turnover above ?200 crores were excluded from the list of comparables, aligning with the precedent set by the Bangalore Bench of ITAT in the case of Auto Desk India Pvt. Ltd. Vs. ACIT.

4. Exclusion based on abnormal profits:
The CIT(A) excluded M/s. Exensys Software Solutions Ltd. and Thirdware Solutions Ltd. due to abnormal profits. The Tribunal noted that abnormal profits alone are not grounds for exclusion unless they result from unusual circumstances. Exensys was excluded due to amalgamation, while Thirdware was excluded based on functional non-comparability, as it was a product company, not a software development service provider.

5. Application of diminishing revenue filter:
The Tribunal dismissed this ground as no company was excluded or included based on the diminishing revenue filter, rendering the issue academic.

6. Inclusion of companies with different accounting years:
The CIT(A) included M/s. Quintegra Solutions Ltd., which had a different accounting year. The Tribunal agreed with the Revenue that this company should be excluded, as the Assessee did not object to its exclusion.

7. Working capital adjustment:
The Tribunal upheld the CIT(A)'s direction to allow working capital adjustment, noting that even the TPO allowed it. Such adjustments are necessary for proper comparison of profit margins.

8. Computation of deduction under Section 10A:
The Revenue contested the CIT(A)'s decision to exclude telecommunication charges from both export turnover and total turnover while computing the deduction under Section 10A. The Tribunal upheld the CIT(A)'s decision, referencing the Karnataka High Court's ruling in CIT v. Tata Elxsi Ltd., which mandates that expenses reduced from export turnover should also be reduced from total turnover. This view was further supported by the Supreme Court in CIT v. HCL Technologies Ltd.

Cross-Objection by the Assessee:
The Assessee sought the exclusion of Sankhya Infotech Ltd. and Four Soft Ltd. from the list of comparables. The Tribunal agreed to exclude Sankhya Infotech Ltd., citing its involvement in software product development and low employee cost, consistent with the ITAT Bangalore Bench's decision in DCIT Vs. M/s. Sharp Software Development (India) Pvt. Ltd.

Conclusion:
The Tribunal partly allowed both the Revenue's appeal and the Assessee's cross-objection, making specific inclusions and exclusions of comparable companies and upholding the CIT(A)'s decisions on working capital adjustment and Section 10A computation. The judgment was pronounced on July 17, 2019.