2017 (3) TMI 1315 - AT - Income Tax

TPA - selection of comparable - Held that - We find merit in the claim of the assessee that the margins of concerns with such huge turnover are not comparable with the margins of the assessee which is a limited risk entity. Accordingly, we direct the Assessing Officer to exclude the margins of Infosys Systems Ltd. from the final set of comparables in order to benchmark the international transaction undertaken by the assessee Pre-operative cost included as part of the operating cost while determining the PLI of the assessee - Held that - The date of registration in the present case is 17-06-2005 and the Associated Enterprise has compensated the assessee for the services provided on cost plus markup basis w.e.f. 01-07-2005. The earlier costs incurred by the assessee for setting up of the business, i.e. for rent, employee cost and administrative expenses cannot form part of the operating cost of the assessee, as the understanding between the parties decide the date from which the assessee would be reimbursed the cost with markup. Accordingly, we hold that the cost of ₹ 39,14,814/- which is the pre-operative expenditure incurred by the assessee, i.e. before starting its activity of providing services to its Associate Enterprise is to be excluded from the operating cost while computing the operating profits. We find before the Hyderabad Bench of the Tribunal in M/s. Market Tools Research Pvt. Ltd. Vs. DCIT 2014 (2) TMI 312 - ITAT HYDERABAD similar issue of pre-operating expenses arose, where the assessee was incorporated on 04-06-2004 and the agreement was entered with the Associated Enterprise on 01-09-2004. The question was in respect of the pre-operative expenses prior to the date of the agreement and it was held that there is no question of considering the preoperating expenses as part of the operating cost. Similar proposition has been laid down by the Bangalore Bench of the Tribunal in KHF Components Pvt. Ltd. Accordingly, we direct the Assessing Officer to exclude the pre-operative expenditure from the operating cost and also similarly make adjustments, if any, in the case of comparable companies finally selected, to benchmark the international transaction of the assessee

Summary

Issues Involved:
1. Allowance of +/-5% benefit on Arm's Length Price (ALP)
2. Rejection of Transfer Pricing (TP) documentation and adjustment in computation of ALP for software development services
3. Inclusion of Infosys Systems Ltd. as a comparable company
4. Inclusion of pre-operative expenses as part of operating costs
5. Charging of interest under sections 234B and 234C of the Income Tax Act

Detailed Analysis:

1. Allowance of +/-5% Benefit on Arm's Length Price (ALP)
The Revenue contested the CIT(A)'s decision to allow a +/-5% benefit on ALP. The Tribunal noted that the issue was covered by the Special Bench decision in M/s. IHG IT Services India Private Ltd. Vs. ITO, which clarified that the benefit of tolerance margin is available only if the variation between the ALP and the actual transaction price does not exceed the tolerance margin. The Tribunal concluded that once the variation exceeds the tolerance margin, no benefit is allowed. Consequently, the grounds of appeal raised by the Revenue were allowed.

2. Rejection of Transfer Pricing (TP) Documentation and Adjustment in Computation of ALP for Software Development Services
The assessee challenged the CIT(A)'s decision to uphold the rejection of its TP documentation and the resultant adjustment in ALP computation. The Tribunal dismissed general grounds of appeal and academic issues raised by the assessee. The Tribunal focused on the rejection of certain comparable companies and the inclusion of pre-operative expenses in operating costs.

3. Inclusion of Infosys Systems Ltd. as a Comparable Company
The assessee argued against the inclusion of Infosys Systems Ltd., citing its significantly higher turnover and brand valuation, making it not functionally comparable. The Tribunal agreed, directing the exclusion of Infosys Systems Ltd. from the final set of comparables. This adjustment meant that no further TP adjustments were necessary, thus partly allowing the assessee's appeal on this ground.

4. Inclusion of Pre-Operative Expenses as Part of Operating Costs
The Tribunal examined whether pre-operative expenses should be included in operating costs for computing operating profits. The assessee argued that these expenses were incurred before the commencement of its software development services and were not reimbursed by the AE. The Tribunal agreed, noting that the expenses were for establishing the business and not for rendering services. Consequently, the Tribunal directed the exclusion of pre-operative expenses from operating costs, allowing the assessee's appeal on this ground.

5. Charging of Interest under Sections 234B and 234C
The Tribunal dismissed the assessee's appeal against the charging of interest under sections 234B and 234C as consequential and not requiring separate adjudication.

Conclusion:
The Tribunal allowed the Revenue's appeal regarding the +/-5% benefit on ALP and partly allowed the assessee's appeal by excluding Infosys Systems Ltd. from the comparables and pre-operative expenses from operating costs. The other grounds raised by the assessee were dismissed.