2015 (3) TMI 401 - AT - Income Tax

Transfer pricing adjustment - TPO while working out the Profit Level Indicator (PLI) of the operating cost/total cost, arrived at a percentage of 6.88% - Held that - Submissions made by the ld. counsel for the assessee have to be accepted and the operating profit to the total cost of the assessee should be adopted at 9% on the basis of the assessee's operating revenue and operating cost. Selection of comparable - Avani Cimcon Technologies Ltd. - Held that - The reasons given by the Assessee for excluding this company as comparable that this company is functionally different from the assessee are found to be acceptable. The decision of ITAT (Mumbai) in the case of Telcordia Technologies Pvt. Ltd. v. ACIT (2012 (6) TMI 388 - ITAT MUMBAI) also supports the plea of the assessee as this company has revenue from software product and observed that in the absence of segmental details, Avani Cincom cannot be considered as comparable. Celestial Labs Ltd. - in the light of the submissions made by the Assessee and the fact that this company was basically/admittedly in clinical research and manufacture of bio products and other products, there is no clear basis on which the TPO concluded that this company was mainly in the business of providing software development services. We therefore accept the plea of the Assessee that this company ought not to have been considered as comparable. KALS Information Systems Ltd - Held that - TPO has drawn conclusions on the basis of information obtained by issue of notice u/s. 133(6) of the Act. This information which was not available in public domain could not have been used by the TPO, when the same is contrary to the annual report of this company as highlighted by the Assessee in its letter dated 21.6.2010 to the TPO. We also find that this company was developing software products and not purely or mainly software development service provider. We therefore accept the plea of the Assessee that this company is not comparable. Accel Transmatic Ltd. - This company was not comparable in the case of the assessees engaged in software development services business. Accepting the argument of the ld. counsel for the assessee, we hold that the aforesaid company should be excluded as comparables. Lucid Software Limited - Due to non-availability of full information about the segmental details as to how much is the sale of product and how much is from the services, therefore, this entity cannot be taken into account for comparability analysis for determining arms length price in the case of the assessee. Infosys Technologies Ltd - lnfosys is a giant in the area of development of software and it assumes all risks, leading to higher profit and cannot be compared with the company which is a captive unit of its parent company assuming only limited currency risk. In view of the above finding, we hold that the Infosys cannot be taken as a comparable for determining the arms length price in the case of the assessee. Wipro Ltd.-IT Services Seqment ('Wipro') - This company is also a global IT Company having varieties of service and products and looking to the magnitude of its operations, sales and expenses, the same cannot be taken into consideration for comparability analysis. Moreover, 67% of its sales relates to its product which are sold on premium resulting into higher profitability, therefore, cannot be compared with the assessee company at all. Flextronics Software Systems Ltd. - From the perusal of the profit and loss account of the said company, it is seen that the revenue sales from services constitutes almost 90% and the product sales is only 10%. Thus, in this case also not much adjustment is required to be made for taking the profit ratio for comparing it with the assessee in determining the arms length price. In view of the above, we hold that TPO has rightly included the said company as comparable case which can be taken into consideration for comparing the profit ratio. Tata Elxsi Limited - Tata Elxsi is engaged in development of niche product and development services, which is entirely different from the assessee company. We agree with the contention of the learned AR that the nature of product developed and services provided by this company are different from the assessee as have been narrated in para 6.6 above. Even the segmental details for revenue sales have not been provided by the TPO so as to consider it as a comparable party for comparing the profit ratio from product and services. Thus, on these facts, we are unable to treat this company fit for comparability analysis for determining the arms length price for the assessee, hence, should be excluded from the list of comparable parties. Megasoft Ltd - In the present case factors for abnormal profits have not been highlighted by the Assessee. In such circumstances it is not possible to accept the submission of the Assessee to exclude this company for the purpose of comparison. Thus the adjustment to be made by way of transfer pricing adjustment and the consequent addition to the total income will be a sum of ₹ 17,32,27,953 and the AO is directed to restrict the addition accordingly. TP adjustment in the Support Services segment of the Appellant - ICC International Agencies Ltd. selected as comparable - Held that - As can be seen from the functional profile of ICC International Agencies Ltd. given by the assessee, which is not disputed by the TPO, that it does trading and also acts as commission agent for machineries used textiles industry. As against this, the functional profile of the assessee, as we have already seen, is only giving support services. Keeping in mind the functions and risk analysis, it is not possible to compare the assessee with ICC International Agencies Ltd. If ICC International Agencies Ltd. is not taken as a comparable, then the margin of the assessee would be well within the OP/Cost PLI of the other comparable companies chosen by the TPO. We accordingly hold that in respect of the international transactions of rendering marketing support services, the price received by the assessee is at arm's length and no adjustment is called for. - Decided in favour of assessee. Deduction u/s. 10A - assessee had allocated common expenses between 10A and non-10A units - Held that - As far as recruitment charges are concerned, the AO's reasons for rejecting the same is on the ground that the STPI unit i.e., the Sec.10-A unit was started in July 2006 and therefore majority of employees recruited would be only for the STPI unit. Therefore the AO held that allocating only 25% of total expenditure on training to Sec.10-A unit was not correct. Secondly, the AO held that the details of employees recruited in STPI unit and Non-STPI unit could not be provided by the Assessee and therefore adverse inference had to be drawn. When the basis of allocation is the number of employees of Sec.10A unit, which fact is not seriously disputed the basis of allocation has to be held as proper. The AO has proceeded on the basis that recruitment cost for Sec.10A unit will be much more than Non-Sec.10A unit. This assumption of the AO in our view is without any basis. In any event turnover cannot be the basis on which these expenses have to be allocated. We therefore hold that allocation on the basis of number of employees is proper. As far as travel and conveyance expenses are concerned, the basis of allocation is on the basis of employees travelling for projects of 10A unit. There can be no objection for this allocation. As far as hotel expenses included in Travel and conveyance expenses is concerned, the basis of allocation is proportionate basis i.e., travel expenditure of 10A unit to the total travel expenditure. As rightly contended on behalf of the revenue when the details of persons travelling for project of 10A unit is available there should be no difficulty in identifying the hotel expenses of employees travelling for project of 10A unit. But allocating such costs on the basis of turnover would also be not appropriate. We are of the view that it would be just and appropriate to set aside the order of the AO on this issue and direct the Assessee to give the details of hotel expenses of employees who travelled for projects of 10A unit and allocate expenses on the basis of available evidence direct or circumstantial. As far as software licenses are concerned, the basis of allocation on the basis of ratio of average head count of 10A unit to the average head count of all units as a whole. The Assessee has done so because software licenses were used both for 10A project and non-10A unit. In such circumstances, the basis of allocation by the Assessee is held to be proper. As far communication expenses are concerned the basis of allocation by the Assessee on the basis of ratio of average head count of the 10A unit to the average head count of all units as a whole is no valid basis. As rightly held by the AO, Communication expenses may be dependent not only on the employee strength but also on the projects allocated to each unit. In the absence of any other details allocating those expenses on the basis of turnover is only accepted method. We therefore are of the view that the AO's basis of allocation has to be upheld.- Decided partly in favour of assessee. Computer software expenses - revenue v/s capital - Held that - This issue requires re-examination by the AO in the light of the principles laid down by the Special Bench in the case of Amway India Enterprises (2008 (2) TMI 454 - ITAT DELHI-C ) wherein principles to be applied in deciding such issues have been laid down - Decided in favour of assessee for statistical purposes.

Summary

Issues Involved:
1. Transfer Pricing Adjustment for Software Development and Support Services
2. Rejection of Comparables by the TPO
3. Allocation of Common Expenses between 10A and Non-10A Units
4. Treatment of Computer Software Expenses

Issue-wise Detailed Analysis:

1. Transfer Pricing Adjustment for Software Development and Support Services:
The assessee challenged the transfer pricing adjustment of Rs. 38,20,29,316 made by the AO. The TPO rejected the assessee's TP documentation and comparability analysis, using a different set of comparables and current year data. The TPO's adjustment was based on a net margin of 6.88%, which the assessee argued should be 9% after correcting the operating cost and revenue calculations. The Tribunal accepted the assessee's submission, adjusting the operating profit to total cost at 9%.

2. Rejection of Comparables by the TPO:
The TPO rejected several comparables selected by the assessee and included others that the assessee argued were not functionally similar. The Tribunal agreed with the assessee, excluding comparables like Avani Cimcon Technologies Ltd., Celestial Labs Ltd., KALS Information Systems Ltd., and others based on functional dissimilarity and abnormal profits. The Tribunal directed the use of only the software services segment margin for Megasoft Ltd. The final adjustment was reduced to Rs. 17,32,27,953 after excluding inappropriate comparables.

3. Allocation of Common Expenses between 10A and Non-10A Units:
The AO reallocated expenses between 10A and non-10A units based on turnover, which the assessee contested. The Tribunal partially accepted the assessee's method of allocation based on the number of employees for certain expenses but upheld the AO's method for others like communication expenses. The Tribunal directed a more detailed examination of hotel expenses related to travel.

4. Treatment of Computer Software Expenses:
The AO treated computer software expenses of Rs. 2,94,28,480 as capital in nature, allowing only depreciation. The assessee claimed these as revenue expenses. The Tribunal remanded the issue to the AO for reconsideration in light of the principles laid down by the Special Bench in the case of Amway India Enterprises v. DCIT.

Conclusion:
The appeal was partly allowed, with significant adjustments to the transfer pricing calculation and a remand for reconsideration of the treatment of software expenses. The Tribunal's decision emphasized the need for accurate functional comparability and appropriate allocation methods for common expenses.