2018 (4) TMI 638 - AT - Income Tax

Transfer pricing addition - comparable selection criteria - functional similarity - Held that - The assessee company is engaged in the design development and maintenance of software for its group companies which essentially includes software architecture coding software testing digital integration software maintenance etc. It also provides some software activity to Indian Customers under independent domestic contracts thus companies functionally dissimilar with that of assessee need to be deselected from final list. Directions to compute ALP of the international transaction by treating foreign exchange fluctuation as an item of operating nature both for the assessee company and comparable companies. Recruitment and Training employees for upgrading their skills - nature of receipt - Held that - In the globalised set up sudden upgradation of knowledge and skill of the IT engineers / technicians for providing IT Software Development Services particularly to foreign AE is also necessary for earning profit by a company. Moreover when undisputedly there is no memorandum of understanding between the assessee company and its employees that the employee will work for specific period as the attribution rate in software industry is highest recruitment of employees and imparting of training to them cannot be considered as of enduring benefit. So by following the law laid down by the Hon ble Calcutta High Court Hindustan Aluminium Corporation Ltd. vs. CIT (1988 (3) TMI 5 - CALCUTTA High Court) and Hon ble jurisdictional High Court in CIT vs. Munjal Showa Ltd 2012 (4) TMI 239 - DELHI HIGH COURT - Decided in favour of the assessee. Payment of retention bonus - allowable busniss expenditure - Held that - As decided in assessee s own case payment of retention bonus made by the assessee company partakes character of salary payable to its employee for the business purposes and has to be treated as revenue expenditure. Had the employees of erstwhile company not been retained by the assessee company its business would have adversely affected and this fact goes to prove that the retention bonus was paid as an incentive to the employee which is salary as per Explanation 2 to section 15 of the Act and is a business expenditure not creating any enduring benefit. - Decided in favour of the assessee.

Issues Involved:

1. Validity of the assessment order.
2. Jurisdictional error in referring the matter to the Transfer Pricing Officer (TPO).
3. Transfer Pricing adjustments and selection of comparables.
4. Treatment of recruitment and training expenses.
5. Treatment of retention bonus as capital expenditure.
6. Allowance of expenses amortized over previous years.
7. Selection of current year data for comparability.
8. Determination of interest under Sections 234B and 234C of the Income Tax Act.
9. Exclusion of specific comparables.
10. Treatment of foreign exchange fluctuation gain/loss.

Detailed Analysis:

1. Validity of the Assessment Order:
The assessee challenged the assessment order dated 31/03/2009, arguing it was "bad in law and void ab-initio." However, the Tribunal did not specifically address this issue in the judgment, implying no substantial grounds were found to invalidate the order.

2. Jurisdictional Error in Referring to TPO:
The assessee contended that the Assessing Officer (AO) did not record reasons for referring the matter to the TPO under Section 92CA(1). This issue was not explicitly resolved in the judgment, suggesting the Tribunal did not find merit in this argument.

3. Transfer Pricing Adjustments and Selection of Comparables:
The Tribunal addressed multiple sub-issues under this head:
- Retention Bonus as Operating Expense: The Tribunal dismissed Ground No. 3.1 as it overlapped with Ground No. 5.
- Exclusion of Thirdware Solutions Ltd.: The Tribunal directed the exclusion of Thirdware Solutions Ltd. as a comparable, noting it engaged in diverse activities without segmental results, making it functionally different from the assessee.
- Foreign Exchange Fluctuation: The Tribunal, referencing its previous order and the Delhi High Court's decision, directed the AO/TPO to treat foreign exchange fluctuation as an operating item for computing the operating margin.
- Working Capital Adjustment: The Tribunal restored the issue to the TPO/AO to provide the benefit of working capital adjustment, following the principle of natural justice.

4. Treatment of Recruitment and Training Expenses:
The Tribunal allowed the appeal, stating that such expenses are recurring and necessary for business, and do not provide an enduring benefit. This decision was consistent with the Tribunal's previous order for the assessee.

5. Treatment of Retention Bonus as Capital Expenditure:
The Tribunal ruled in favor of the assessee, treating the retention bonus as revenue expenditure under Section 37 of the Act. This was based on the rationale that the bonus was an incentive necessary for retaining key employees, thus qualifying as a business expenditure.

6. Allowance of Expenses Amortized Over Previous Years:
The Tribunal did not provide a detailed analysis for this issue, implying that the treatment of such expenses was either resolved in favor of the assessee or not contested further.

7. Selection of Current Year Data for Comparability:
The Tribunal did not explicitly address this issue, suggesting it was either resolved in favor of the assessee or not significantly contested.

8. Determination of Interest Under Sections 234B and 234C:
The Tribunal did not provide a detailed analysis, implying that the interest determination was either accepted as per the AO's calculation or not significantly contested.

9. Exclusion of Specific Comparables:
The Tribunal directed the exclusion of Thirdware Solutions Ltd. but did not contest Mindtree Ltd., as the assessee did not pursue it during the hearing.

10. Treatment of Foreign Exchange Fluctuation Gain/Loss:
The Tribunal ruled in favor of the assessee, directing the AO/TPO to treat foreign exchange fluctuation as an operating item, consistent with the Tribunal's previous decision and the Delhi High Court's ruling.

Conclusion:
The appeal was partly allowed for statistical purposes, with specific directions to the AO/TPO to reconsider certain adjustments and exclusions. The Tribunal's decisions were largely based on consistency with previous rulings and adherence to principles of natural justice.

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