2014 (2) TMI 560 - AT - Income Tax

Determination of Arms Length Price International Transactions undertaken Selection of Comparables Held that - The decision in Intoto Software India (P.) Ltd. Versus Assistant Commissioner of Income-tax, Circle -2(1), Hyderabad 2013 (10) TMI 599 - ITAT HYDERABAD followed - The assessee is a captive service provider to the group companies and is providing services on cost plus mark- up basis TPO in his order has brought out the differences between a product company and a software development services provider - he is aware of the functional dissimilarity between a product company and a software development service provider - the Assessing Officer ought not to have taken the companies which are into both the product development as well as software development service provider as comparables unless the segmental details are available - The percentage of expenditure towards the development of software products may differ from company to company and also it may not be proportionate to the sales from the sale of software products u/s 133(6) of the I.T. Act, the TPO has the power to call for the necessary details from the comparable companies - the Assessing Officer/TPO has exercised this power to call for details with regard to the various companies - The method adopted by the TPO to allocate expenditure proportionately to the software development services and software product activity cannot be said to be correct and reasonable - Wherever, the Assessing Officer/TPO cannot make suitable adjustment to the financial results of the comparable companies with the assessee-company to bring them on par with the assessee, these companies are to be excluded from the list of comparables thus, the AO/TPO directed to exclude the comparables as ordered Decided in favour of Assessee. Risk adjustment relief Held that - The TPO has accepted that assessee has a risk free entity and risk adjustment is required - However, as against 7.6% quantified by the assessee, the A.O. arrived at risk adjustment of 0.85% - Even this was not granted to the assessee thus, the TPO is directed to re-examine the issue and grant risk adjustment after analysing the risk prevailed to the assessee company vis-a-vis the other companies Decided in favour of Assessee.

Summary

Issues Involved:
1. Determination of Arm's Length Price (ALP) on international transactions.
2. Selection of comparable companies.
3. Risk adjustment relief.

Detailed Analysis:

1. Determination of Arm's Length Price (ALP) on International Transactions:
The assessee, a private limited company engaged in software development services to its Associated Enterprises (AEs), filed a return of income for AY 2005-2006. The matter was referred to the Transfer Pricing Officer (TPO) due to international transactions. The TPO selected revised comparable companies and determined the arm's length margin at 26.54%, resulting in an upward adjustment of Rs.1,31,16,086/-. The Assessing Officer (A.O.) incorporated the TPO's order in the assessment without allowing any deduction under section 10A on the adjusted amount.

2. Selection of Comparable Companies:
The assessee objected to the inclusion of certain comparables selected by the TPO. The CIT(A) retained all comparables identified by the TPO except one (Satyam Computer Services Ltd.), reducing the arm's length margin to 26.41%. The Tribunal considered the objections to the comparables and provided detailed reasons for their inclusion or exclusion:

- Exensys Software Solutions Ltd.: Excluded due to extraordinary events like amalgamation affecting financial results.
- Infosys Technologies Ltd.: Excluded due to incomparable scale of operations, high turnover, and ownership of branded products.
- Flextronics Software Ltd., Four Soft Ltd., Thirdware Software Solutions Ltd.: Excluded as they are involved in both software services and product development, lacking segmental details for comparison.
- Tata Elxsi Ltd.: Directed TPO to examine segmental profits; if not available, exclude from comparables.
- Geometric Software Solutions Co. Ltd.: Accepted as comparable due to functional similarity.
- Sankhya Infotech Ltd.: Directed TPO to re-examine and include only if functionally similar.

3. Risk Adjustment Relief:
The assessee, being a risk-free entity remunerated on a cost-plus basis, requested a risk adjustment of 7.6% using the Capital Asset Pricing Model (CAPM). The TPO calculated a risk adjustment of 0.85% but did not grant it, considering it insignificant. The Tribunal directed the TPO to re-examine and grant appropriate risk adjustment after analyzing the risk profile of the assessee vis-a-vis the comparables.

Conclusion:
The appeal was allowed for statistical purposes, directing the TPO to re-examine the selection of comparables and risk adjustment. The Tribunal emphasized the need for functional similarity and proper segmental data for comparables and recognized the risk-free nature of the assessee's operations. The order was pronounced in the open court on 12.02.2014.