2017 (7) TMI 953 - AT - Income Tax

TPA - ALP determination - selection of comparable - selection criteria - Held that - The issue is now settled that high profit or loss cannot be a criteria for inclusion or exclusion of companies in the set of comparables. However, if the high profit or loss is by the reason of some extraordinary circumstances then those extraordinary circumstances which has led to the high profit or loss can be considered as a criteria for inclusion or exclusion of the companies in the list of comparables. Therefore, the mere high profit margin or loss cannot be considered as a parameter or criteria for selection of comparable companies Assessee is a subsidiary of Exeter Educational Management Systems Inc. USA and provides software development services for the administration of higher education institutions worldwide thus companies functionally dissimilar with that of assessee need to be deselected from final list of comparable. Eligible for deduction u/s. 10A - denial of reversal of provision for management charges payable to its parent company - Held that - Referring to assessees s submission that this amount was allowed as business expenditure in the earlier year and therefore the business profit of the assessee for the purpose of deduction u/s. 10A was reduced by this amount in the earlier year also as during the year under consideration the assessee has reversed the provision which has resulted increase in the business income of the assessee and therefore it is eligible for deduction u/s. 10A this fact of provision being allowed as business expenditure in the earlier year has not been verified by the authorities below and therefore in the absence of any finding on this issue by the authorities below it is not possible to give a concluding finding at this stage. Thus in the facts and circumstances of the case we set aside this issue to the record of the AO for verification

Summary

Issues Involved:
1. Write back of Provision for Management Charges
2. Adjustment to the Arm's Length Price (ALP)
3. Related Party Transaction (RPT) Filter
4. Exclusion of Companies with High Profit Margins
5. Functional Comparability of Selected Companies
6. Computation of Deduction under Section 10A

Detailed Analysis:

1. Write back of Provision for Management Charges:
The assessee reversed a provision for management charges payable to its parent company amounting to ?801,775 and claimed a 10A deduction on this amount, treating it as business income. The AO disallowed the claim, stating that the reversal was not derived from the export of computer software. The CIT(A) dismissed the appeal, considering the reversal as merely an accounting entry. The Tribunal remanded the issue back to the AO for verification of whether the provision had been allowed as a business expenditure in the earlier year, which would justify the 10A deduction on its reversal.

2. Adjustment to the Arm's Length Price (ALP):
The assessee's TP study selected seven comparable companies with a mean margin of 9.70%, while the TPO selected 17 comparables with an adjusted mean margin of 29.09%. The CIT(A) excluded 13 companies based on a 0% related party transaction filter and high profit margins, leaving four comparables with an average margin of 23.034%. The Tribunal directed the AO/TPO to exclude seven companies from the set of comparables and reconsider the functional comparability of Geometric Software Solutions Ltd. by verifying the RPT.

3. Related Party Transaction (RPT) Filter:
The TPO applied a 25% RPT filter, while the CIT(A) applied a 0% RPT filter. The Tribunal found a 0% RPT filter impractical and held that a 15% tolerance range was reasonable. The Tribunal set aside the CIT(A)'s order and modified the TPO's order to apply a 15% tolerance range for RPT.

4. Exclusion of Companies with High Profit Margins:
The CIT(A) excluded companies like Exensys Solutions Ltd. and Thirdware Solutions Ltd. due to high profit margins. The Tribunal held that high profit or loss alone cannot be a criterion for exclusion unless caused by extraordinary circumstances. The Tribunal directed the AO/TPO to exclude Exensys Software Solutions Ltd. due to an extraordinary event of amalgamation during the year.

5. Functional Comparability of Selected Companies:
The Tribunal examined the functional comparability of ten companies. It excluded companies like Infosys Technologies Ltd., Tata Elxsi Ltd. (Seg.), and Satyam Computer Services Ltd., citing reasons such as high turnover, brand value, and financial irregularities. The Tribunal directed the AO/TPO to exclude these companies from the list of comparables and reconsider the functional comparability of Geometric Software Solutions Ltd. by verifying the RPT.

6. Computation of Deduction under Section 10A:
The CIT(A) excluded certain expenses from the total turnover for computing the 10A deduction, which the Revenue contested. The Tribunal upheld the CIT(A)'s decision, stating that the exclusion of expenses like traveling, technical fees, and other expenses from the total turnover was correct for computing the 10A deduction.

Conclusion:
The Tribunal provided a detailed analysis of the issues, remanding certain matters back to the AO/TPO for verification and reconsideration. It upheld the CIT(A)'s application of certain filters and exclusions while modifying others, ensuring a fair and comprehensive assessment of the assessee's claims and the Revenue's objections.