2020 (11) TMI 411 - AT - Income Tax

Transfer pricing adjustment - Provision of software development services only - Comparable selection - HELD THAT - Companies functionally dissimilar with that of assessee need to be deselected from final list. We direct the AO/TPO to compute the ALP of the international transaction in accordance with the directions given above, after affording adequate opportunity of being heard to the assessee. We hold that the assessee cannot be precluded from challenging the inclusion of comparable companies, which had been accepted earlier by the assessee. Deduction u/s 10A - whether the expenses incurred in foreign currency are required to be reduced from export turnover while computing deduction u/s 10A? - HELD THAT - In the case of Tata Elxsi Ltd, 2020 (3) TMI 1082 - KARNATAKA HIGH COURT exclusion of expenses incurred in foreign currency from both export turnover and total turnover while computing deduction u/s 10A - Also see HCL TECHNOLOGIES LTD. 2018 (5) TMI 357 - SUPREME COURT . Gain/loss arising on account of fluctuation in foreign exchange is operating income/expenses - HELD THAT - DRP has directed the AO to consider the foreign exchange fluctuation gain/loss on revenue account in respect of assessee company and also in respect of comparable companies while determining the margin in the case of the assessee company, if in the earlier years, the foreign exchange fluctuation was treated as operating in nature for the purpose of consistency. 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.

Issues Involved:
1. Reduction of expenses incurred in foreign currency from "export turnover."
2. Addition made towards transfer pricing adjustment.
3. Non-granting of TDS as claimed by the assessee.
4. Nature of foreign exchange gains/losses as operating or non-operating.
5. Directions by the DRP regarding the exclusion of expenses from both export turnover and total turnover.
6. Relief granted by the DRP in respect of transfer pricing adjustment.

Detailed Analysis:

1. Reduction of expenses incurred in foreign currency from "export turnover":
The assessee contested whether expenses incurred in foreign currency should be reduced from "export turnover" while computing the deduction under section 10A of the Act. The revenue also raised the issue of whether the DRP was justified in directing the AO to follow the Karnataka High Court's decision in Tata Elxsi Ltd, which mandated the exclusion of such expenses from both export turnover and total turnover. The Tribunal upheld the DRP's decision, referencing the Supreme Court's ruling in CIT vs. HCL Technologies Ltd, which stated that expenses excluded from export turnover must also be excluded from total turnover to maintain the formula's workability.

2. Addition made towards transfer pricing adjustment:
The TPO made a transfer pricing adjustment concerning the provision of software development services by the assessee, which was contested by both parties. The TPO selected 13 comparable companies with an average margin of 24.82%, leading to an adjusted margin of 25.44% and a transfer pricing adjustment of ?30.24 crores. The DRP directed the exclusion of ten companies and upheld the inclusion of three. The Tribunal confirmed the exclusion of the seven companies based on precedents and directed the inclusion of three companies, Evoke Technologies Ltd, R.S Software India Ltd, and Mindtree Limited, as comparables. The Tribunal also directed the exclusion of Persistent Systems Ltd, Persistent Systems & Solutions Ltd, and Sasken Communications Ltd, following the decisions in similar cases.

3. Non-granting of TDS as claimed by the assessee:
The assessee raised the issue of non-granting of TDS credit. The Tribunal restored this matter to the AO for verification, as it required further examination.

4. Nature of foreign exchange gains/losses as operating or non-operating:
The revenue challenged the DRP's decision that foreign exchange gains/losses were operating in nature. The DRP had followed the Tribunal's decisions in Sap Labs India (P) Ltd and Cisco Systems Services BV, treating foreign exchange fluctuation gains/losses on trade debtors and creditors as operating income/expenses. The Tribunal found no infirmity in the DRP's decision, affirming the treatment of foreign exchange fluctuations as operating in nature for consistency.

5. Directions by the DRP regarding the exclusion of expenses from both export turnover and total turnover:
The DRP directed the AO to exclude expenses incurred in foreign currency from both export turnover and total turnover, aligning with the Karnataka High Court's decision in Tata Elxsi Ltd. The Tribunal upheld this direction, following the Supreme Court's ruling in CIT vs. HCL Technologies Ltd, ensuring the formula for computing deductions under section 10A remained workable.

6. Relief granted by the DRP in respect of transfer pricing adjustment:
The DRP had granted relief by excluding ten comparable companies and retaining three. The Tribunal confirmed the exclusion of the seven companies and directed the inclusion of three companies as comparables. It also directed the exclusion of Persistent Systems Ltd, Persistent Systems & Solutions Ltd, and Sasken Communications Ltd, following similar case decisions. The Tribunal instructed the AO/TPO to recompute the ALP of the international transaction accordingly.

Conclusion:
The Tribunal allowed the assessee's appeal and partly allowed the revenue's appeal, directing specific inclusions and exclusions of comparable companies for transfer pricing adjustments, upholding the exclusion of foreign currency expenses from both export and total turnover, and treating foreign exchange fluctuations as operating income/expenses. The issue of TDS credit was remanded to the AO for verification.

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