2021 (9) TMI 1379 - AT - Income Tax

TP Adjustment - exclusion of comparable companies in the SWD services - HELD THAT - Acropetal Technologies Ltd should be excluded from the list of comparable companies in the case of companies engaged in rendering SWD services such as the Assessee. We therefore direct exclusion of this company from the list of comparable companies. Exclusion of E-Infochips Ltd. ought to be excluded from list of comparable companies in the case of companies rendering SWD services similar to that of the Assessee. ICRA Techno Analytics Ltd. is engaged in diversified activities of software development and consultancy, licensing and sublicensing, annual maintenance for software support, web development hosting and revenue from all the activities are reported under one segment, without any segmental information regarding the same made available. Therefore, in the absence of segmental information, it cannot be ascertained whether the company passes all the filters applied by the TPO and therefore ought to stand excluded from the final list of comparables. E-Zest Solution Ltd. is concerned, this company was directed to be excluded by this Tribunal in the case of a SWD service provider such as the Assessee as functionally not comparable and absence of segmental information of its products and software development segments and also in the light of presence of inventory showing that this company is a product company. As far as exclusion of Persistent Systems and Solutions Ltd., is concerned, we find that this company was again excluded in the decision in the case of Autodesk India Pvt. Ltd. 2018 (12) TMI 1742 - ITAT BANGALORE for the very same reasons for exclusion of e-Zest solutions Ltd. We therefore direct exclusion of this company from the list of comparable companies. Computation of deduction u/s 10A - exclusion of telecommunication expenses and expenses incurred in foreign currency for rending technical services outside India, both from the export turnover and total turnover - HELD THAT - It is not in dispute before us that the Hon ble High Court of Karnataka in the case of CIT v. Tata Elxsi Ltd 2011 (8) TMI 782 - KARNATAKA HIGH COURT has held that charges/expenses relating to telecommunication, and expenses in connection with rendering technical services outside India, should be excluded both from export turnover and total turnover while computing deduction u/s.10A of the Act i.e., whatever is removed from the numerator should also be excluded from the denominator while working total turnover and export turnover for allowing deduction u/s.10A. The aforesaid decision of the jurisdictional High Court has been upheld by the Hon ble Supreme Court in the case of CIT v. HCL Technologies Ltd. 2018 (5) TMI 357 - SUPREME COURT - In view of the above, we are of the view that the telecommunication charges should be excluded both from the export turnover as well as total turnover while computing deduction u/s.10A of the Act. The order of the DRP is therefore upheld. Considering gains/loss arising from fluctuation of foreign currency as being operating in nature - as submitted that the gains on account of fluctuation in foreign currency has arisen from the international transaction of provision of ITE services and SWD services - HELD THAT - The Hon ble Delhi High Court in the case of PCIT Vs. B.C. Management Services (P) Ltd. 2017 (12) TMI 255 - DELHI HIGH COURT held that foreign exchange gain has to be regarded as part of operating income by following its own order in Pr. CIT v. Cashedge India (P.) Ltd. 2016 (5) TMI 1348 - DELHI HIGH COURT .Respectfully following the said decision, we uphold the directions of the DRP and dismiss Gr.No.3 to 5 raised by the Revenue. Exclusion of comparable companies in ITeS segments - Acropetal cannot be considered as a comparable to assessee performing routine low end IT enabled services function. This company is therefore to be excluded from the list of comparable companies. Jeevan Scientific Technology Ltd., we find that this company is engaged in diverse functions and the same were reported under one segment without segmental details regarding the same being made available. Without segmental details, the comparability of the company cannot be determined. In any event, the ERP segment of the company is not comparable to the assessee, the BPO segment of the company fails the filter of service income being greater than 75% of total revenue, and the company suffers from huge fluctuations which indicate that certain peculiar circumstances influencing the profit margin of the company exist, for which appropriate adjustments cannot be made to balance the effect. This company is therefore excluded as comparable company. Accentia Technologies Ltd is engaged in rendering routine low end information technology enabled services. Further, the said company not only does medical transcriptions, but has also ventured into healthcare receivables cycle management and high end consultancy to start-ups requiring field experts. As can be seen from the annual report, coding income is contributing 15% of the total income which activities are akin to software development activity while the assessee is a mere provider of IT enabled services. The company has invested huge sums in the development of EMR software. Segmental details of its various activities are unavailable, therefore, not comparable to the Assessee and rejected as a comparable. ICRA Online Ltd is functionally dissimilar for the reason that the outsourced services segment of the company is engaged in the provision of high end consultancy services which cannot be compared to the assessee who is into provision of low end IT enabled services which are routine in nature. Further, the company fails the TPO s own filter of export turnover in excess of 75% of total sales as the export turnover of the company amount to only 61.88% of its sales. Therefore, the company cannot be held as a comparable to the assessee.

Summary

Issues Involved:

1. Determination of Arm's Length Price (ALP) for Software Development Services (SWD) and Information Technology Enabled Services (ITeS).
2. Exclusion of certain companies from the list of comparables.
3. Treatment of foreign exchange gains/losses as operating or non-operating income.
4. Exclusion of telecommunication and foreign currency expenses from export and total turnover for Section 10A deduction.

Detailed Analysis:

1. Determination of Arm's Length Price (ALP) for Software Development Services (SWD) and Information Technology Enabled Services (ITeS):

The Assessee, a wholly owned subsidiary of a US-based company, engaged in international transactions involving SWD and ITeS. The Transaction Net Margin Method (TNMM) was agreed upon as the Most Appropriate Method (MAM) for determining ALP. The Transfer Pricing Officer (TPO) selected a final set of 13 comparable companies for SWD services and 10 for ITeS, computing the arithmetic mean of profit margins for comparison with the Assessee’s profit margin.

2. Exclusion of Certain Companies from the List of Comparables:

Software Development Services Segment:

- Acropetal Technologies Ltd.: Excluded due to failing the employee cost filter (11.51% vs. required 25%) and service revenue filter (software development income not exceeding 75% of total revenue). Previous Tribunal decisions supported this exclusion.
- E-Infochips Ltd.: Excluded for failing the software service income filter (less than 75% of total revenue) and lack of segmental information for its diverse activities.
- ICRA Techno Analytics Ltd.: Excluded due to lack of segmental information and engagement in diversified activities, making it incomparable to the Assessee.
- e-Zest Solution Ltd. and Persistent Systems and Solutions Ltd.: Excluded due to functional dissimilarity and absence of segmental information, as supported by previous Tribunal decisions.

Information Technology Enabled Services Segment:

- Acropetal Technologies Ltd.: Excluded due to lack of segmental details and engagement in high-end IT enabled services, which are not comparable to the Assessee’s routine services.
- Jeevan Scientific Technology Ltd.: Excluded due to diverse functions reported under one segment, failing the service income filter, and presence of peculiar profit margin fluctuations.
- Accentia Technologies Ltd.: Excluded due to engagement in high-end KPO services, diverse functions without segmental details, and ownership of significant intangibles.
- ICRA Online Ltd.: Excluded due to lack of segmental details and functional dissimilarity, as it provides high-end consultancy services and fails the export turnover filter.

3. Treatment of Foreign Exchange Gains/Losses:

The Revenue's appeal against the DRP’s direction to treat foreign exchange gains/losses as operating income was dismissed. The Tribunal upheld that such gains/losses are inextricably related to the main services and should be treated as operating in nature, following decisions from the Hon’ble Delhi High Court and other cases.

4. Exclusion of Telecommunication and Foreign Currency Expenses:

The Tribunal upheld the DRP's direction to exclude telecommunication and foreign currency expenses from both export turnover and total turnover for computing the deduction under Section 10A. This decision aligns with the Hon’ble Karnataka High Court’s ruling in CIT v. Tata Elxsi Ltd., which was upheld by the Hon’ble Supreme Court in CIT v. HCL Technologies Ltd.

Conclusion:

The Tribunal directed the TPO to compute the ALP in accordance with the Tribunal’s directions, allowing the Assessee’s appeal partly and dismissing the Revenue’s appeal. The decision emphasized the importance of functional comparability and adherence to established filters and judicial precedents in transfer pricing cases.