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2020 (10) TMI 1356 - AT - Income TaxTP Adjustment - comparable selection - HELD THAT - Companies functinally disimilar of assessee's software development services to its Associated Enterprises (AEs) and if RPT was beyond the threshold limit of 15% need to be deselcted from final list. Deduction u/s 10A - whether the Ld DRP was justified in directing the AO to follow the decision of Tata Elxsi Ltd, 2011 (8) TMI 782 - KARNATAKA HIGH COURT i.e., exclusion of expenses incurred in foreign currency from both export turnover and total turnover - HELD THAT - The Hon'ble Supreme Court has settled this issue in the case of CIT vs. HCL Technologies Ltd 2018 (5) TMI 357 - SUPREME COURT held even in common parlance, when the object of the formula is to arrive at the profit from export business, expenses excluded from export turnover have to be excluded from total turnover also. Otherwise, any other interpretation makes the formula unworkable and absurd. Hence, we are satisfied that such deduction shall be allowed from the total turnover in same proportion as well. On the issue of expenses on technical services provided outside, we have to follow the same principle of interpretation as followed in the case of expenses of freight, telecommunication etc., otherwise the formula of calculation would be futile. Hence, in the same way, expenses incurred in foreign exchange for providing the technical services outside shall be allowed to exclude from the total turnover. Gain/loss arising on account of fluctuation in foreign exchange as operating income/expenses - HELD THAT - DRP has followed the decision rendered by the Tribunal in the case of Sap Labs India (P) Ltd 2010 (8) TMI 676 - ITAT, BANGALORE and Cisco Systems Services BV 2014 (10) TMI 852 - ITAT BANGALORE and accordingly held that the foreign exchange fluctuation gain/loss arising to the assessee on realization of trade debtors, payment to creditors etc were nothing but operation income. DRP has directed the AO to consider the foreign exchange fluctuation gain/loss as operating in nature both in the hands of the assessee and in the hands of comparable companies. Since the ld DRP has followed the decision rendered by the Tribunal in this regard, we do not find any infirmity in its decision rendered on this issue. Appeal of the assessee is treated as allowed and the appeal of the revenue is treated as partly allowed.
Issues Involved:
1. Addition made towards transfer pricing adjustment. 2. Whether foreign exchange gains/losses are operating in nature. 3. Justification of the DRP's direction to exclude expenses incurred in foreign currency from both export turnover and total turnover. 4. Relief granted by DRP in respect of addition made on account of transfer pricing adjustment. Detailed Analysis: 1. Addition Made Towards Transfer Pricing Adjustment: The assessee, a wholly-owned subsidiary providing software development services, adopted the Transactional Net Margin Method (TNMM) with an Operating Profit/Operating Cost (OP/OC) margin of 11.48%. The TPO, however, selected 13 comparable companies with an average margin of 24.82%, leading to a transfer pricing adjustment of Rs.4.38 crores after a working capital adjustment of 1.26%. The DRP directed the exclusion of ten comparables, retaining only three. The assessee contested the inclusion of Persistent Systems & Solutions Ltd, Persistent Systems Ltd, and Sasken Communications Technologies Ltd, while seeking the inclusion of R.S. Software Ltd, Evoke Technologies Ltd, and Mindtree Ltd. The Tribunal upheld the exclusion of the seven companies based on precedents set in cases like M/s LG Soft India P Ltd and M/s AMD India Private Limited, confirming the exclusion of diverse and functionally dissimilar companies. 2. Whether Foreign Exchange Gains/Losses are Operating in Nature: The DRP followed the Tribunal’s decisions in cases like Sap Labs India (P) Ltd and Cisco Systems Services BV, holding that foreign exchange fluctuation gains/losses arising from trade debtors and creditors are operational in nature. This was upheld by the Tribunal, affirming that such gains/losses should be considered operating income/expenses for both the assessee and comparable companies. 3. Justification of DRP's Direction to Exclude Expenses Incurred in Foreign Currency from Both Export Turnover and Total Turnover: The DRP directed the AO to follow the Karnataka High Court's decision in Tata Elxsi Ltd, which mandates the exclusion of expenses incurred in foreign currency from both export turnover and total turnover. The Supreme Court in CIT vs. HCL Technologies Ltd. confirmed this approach, ensuring the formula for calculating export profits remains workable and consistent. The Tribunal upheld the DRP's decision, aligning with the Supreme Court’s ruling. 4. Relief Granted by DRP in Respect of Addition Made on Account of Transfer Pricing Adjustment: The Tribunal addressed the revenue's challenge against the DRP's exclusion of ten comparables. The Tribunal upheld the exclusion of seven comparables based on functional dissimilarity and lack of segmental details, consistent with precedents. The Tribunal also directed the inclusion of three companies (Evoke Technologies Ltd, R.S. Software India Ltd, and Mindtree Ltd) as requested by the assessee, following consistent judicial decisions. Conclusion: The Tribunal's order resulted in the assessee's appeal being allowed and the revenue's appeal being partly allowed. The Tribunal directed the AO/TPO to recompute the ALP of the international transaction, ensuring compliance with the directions and providing the assessee with an opportunity to be heard. The order was pronounced in the open court on 21st Oct 2020.
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