2016 (11) TMI 114 - AT - Income Tax

Exclusion of expenses incurred in foreign currency from the export turnover while computing the deduction under Section 10A - Held that - This issue is covered by the decision of the Hon ble jurisdictional High Court of Karnataka in the case of CIT V Tata Elxsi Ltd & Others (2011 (8) TMI 782 - KARNATAKA HIGH COURT ) wherein it has been held that while computing the exemption u/s 10A, if the export turnover in the numerator is to be arrived at after excluding certain expenses, the same should also be excluded from the total turnover in the denominator.

Summary

Issues Involved:
1. Exclusion of expenses incurred in foreign currency from export turnover while computing deduction under Section 10A.
2. Transfer Pricing Adjustment and selection of comparables by the Transfer Pricing Officer (TPO).

Detailed Analysis:

1. Exclusion of Expenses Incurred in Foreign Currency from Export Turnover:
The revenue contested the exclusion of expenses incurred in foreign currency from both export turnover and total turnover while computing the deduction under Section 10A of the Income Tax Act, 1961. The Tribunal upheld the CIT (Appeals) decision to exclude these expenses from both export turnover and total turnover, referencing the Karnataka High Court's ruling in CIT v. Tata Elxsi Ltd. & Others. The High Court emphasized that for accurate computation, the same expenses excluded from export turnover should also be excluded from total turnover to avoid anomalies and ensure fairness in the formula used for deductions under Section 10A.

2. Transfer Pricing Adjustment and Selection of Comparables:
The Transfer Pricing Officer (TPO) had selected 20 comparables for benchmarking the international transactions of the assessee, who is engaged in software development services. The CIT (Appeals) applied a turnover filter of ?1 Crore to ?200 Crores and excluded eight comparables due to their high turnover. Additionally, the CIT (Appeals) excluded Celestial Biolabs Ltd. for its high profit margins and functional dissimilarity, and three more companies (Avani Cincom Technology Ltd., KALS Information System Ltd., and Bodhtree Consultancy Ltd.) for functional dissimilarity. The CIT (Appeals) included Indus Network Ltd., which was excluded by the TPO based on the employee cost filter.

The Tribunal reviewed these decisions and referenced earlier Tribunal decisions, including in the case of Telelogic India Pvt. Ltd. The Tribunal agreed with applying a turnover filter but suggested a multiple of 10 times the assessee’s turnover for selecting comparables. It directed the exclusion of several companies based on functional dissimilarity and high turnover, specifically excluding companies like Infosys Ltd. and Wipro Ltd., which have significant intangibles and high turnover, and companies like Persistent Systems Ltd. and Tata Elxsi Ltd. for their involvement in product development and lack of segmental data.

The Tribunal also addressed the inclusion of Indus Network Ltd., emphasizing the importance of the employee cost filter. Since Indus Network Ltd. had an employee cost below 25%, it was deemed not comparable to the assessee, which primarily engages in software development services through its employees.

Conclusion:
The Tribunal upheld the CIT (Appeals) decision on excluding foreign currency expenses from both export and total turnover. It also directed the TPO to apply a turnover multiple of 10 times the assessee’s turnover for selecting comparables and to exclude certain companies based on functional dissimilarity and high turnover. The Tribunal emphasized the consistent application of filters such as employee cost and related party transactions (RPT) at 15% for selecting comparables. The revenue’s appeal and the assessee’s cross-objection were partly allowed, directing the TPO to recompute the Arm's Length Price (ALP) accordingly.