2014 (6) TMI 371 - AT - Income Tax

Transfer pricing adjustment - International transactions for software development services provided to AE Determination of operating cost Held that - The cost of development of new product seems to be not on the assessee but on the AE - However, these contentions were neither examined nor commented upon by either of the revenue authorities - in the absence of any clarity on the issue, no finding could be given either to exclude the amount or include the amount as part of operating cost the Revenue itself has excluded the earlier R & D expenditure from the computation of operating cost, assessee s contention seems to be genuine, if such expenditure was R & D for development of future products thus, the matter is liable to be remitted back to the TPO for fresh adjudication about the nature of expenditure incurred and why the amount was not categorised as R & D expenditure and whether any product was developed to which this expenditure was capitalized or claimed as relating to in later years also the issue of operating cost is also remitted back to the TPO - Decided in favour of Assessee. Selection of comparables Functionally dissimilar Employee cost filter Held that - Following Trilogy E-Business Software India (P.) Ltd. Versus Deputy Commissioner of Income-tax. Circle 12(4). Bangalore 2013 (1) TMI 672 - ITAT BANGALORE - The 14 comparables are required to be excluded by the TPO these Companies are directed to be excluded from the list of comparables as assessee turnover is only 2.18 crores and employee cost is more - Many of the companies are also found to be not functionally similar. The various filters and reasons accepted in other cases do apply to the assessee as TPO selected same 26 comparables in all the cases relied on and decided earlier in various cases - the mean PLI of the rest of the comparables selected by the TPO would come to 18.66% and this is within the margin as arrived at by the assessee after excluding the R&D cost Decided in favour of Assessee.

Summary

Issues Involved:

1. Determination of operating costs.
2. Selection of comparables for Transfer Pricing (T.P.) analysis.
3. Negative working capital adjustment.
4. Setting off carried forward losses.

Detailed Analysis:

1. Determination of Operating Costs:

The primary issue here revolves around the proper calculation of operating costs. The assessee reported a total expenditure of Rs. 10,72,46,059/- against total receipts of Rs. 2,77,97,662/-. The TPO excluded R&D expenditure written off (Rs. 2,74,97,491/-) and an extraordinary item (Rs. 42,00,357/-) from the operating cost, which was not disputed. However, the contention arose over an additional Rs. 5.66 crores claimed by the assessee as R&D expenditure for developing new products, which the TPO included in the operating cost. The Tribunal noted that neither the TPO nor the DRP examined this expenditure's nature. Therefore, the Tribunal remanded the issue back to the TPO/AO for fresh examination to determine whether this amount should be excluded from the operating cost.

2. Selection of Comparables for T.P. Analysis:

The assessee objected to the inclusion of certain comparables selected by the TPO. The Tribunal agreed with the assessee's objections based on precedents and directed the exclusion of the following 14 comparables:

- Accel Transmatic Ltd.
- Avani Cimcon Technologies Ltd.
- KALS Information Systems Ltd.
- Lucid Software Ltd.
- Ishir Infotech Ltd.
- Flextronics Software Systems Ltd.
- Infosys Technologies Ltd.
- Tata Elxsi Ltd.
- Wipro Ltd.
- iGate Global Solutions Ltd.
- Mindtree Ltd.
- Persistent Systems Ltd.
- Sasken Communication Technologies Ltd.
- Helios and Matheson Information Technology Ltd.

The Tribunal noted that these companies were either functionally dissimilar, failed the employee cost filter, or had high turnovers, making them unsuitable for comparison with the assessee.

3. Negative Working Capital Adjustment:

The Tribunal acknowledged the issue of negative working capital adjustment but noted that the assessee had not raised specific objections before them, though a ground was raised. The Tribunal directed the AO/TPO to re-examine this aspect in light of the revised T.P. computation after determining the operating cost and excluding the inappropriate comparables.

4. Setting Off Carried Forward Losses:

The assessee raised an issue regarding the non-adjustment of carried forward losses against the assessed income. The Tribunal directed the AO to verify the earlier orders and records to ensure the proper setting off of these losses as per the facts and law.

Conclusion:

The appeal was allowed for statistical purposes. The Tribunal directed the AO/TPO to re-examine the operating costs, exclude the inappropriate comparables, and re-compute the arithmetic mean of the remaining comparables. Additionally, the AO was instructed to verify and adjust the carried forward losses appropriately. The order was pronounced in the open court on 28.05.2014.