2015 (3) TMI 448 - AT - Income Tax

Transfer pricing adjustment - determination of Arm s Length Price - selection of comparable - improper application of the RPT filter by the CIT(A) - Held that - It is not in dispute before us that this Tribunal, in the cases of 24/7 Customer Pvt. Ltd. (2013 (1) TMI 45 - ITAT BANGALORE ), and Sony India Private Ltd.(2008 (9) TMI 420 - ITAT DELHI-H) and various other cases has taken a view that comparables having RPT of upto 15% of total revenues can be considered. In view thereof, the Revenue s on this ground has to be allowed. It is held that the CIT(A) ought to have adopted a threshold limit of 15% of the total revenue attributable to related party transaction as ground for rejecting comparable companies. Consequently it is held that comparable companies having RPT upto 15% of the total revenues alone can be included. The Revenue s contention that comparables with RPT upto 25% can be considered is without any basis. As regards the standard deduction of 5% of the arm s length price afforded to the Appellant by the CIT(A), it is not in dispute before us that in view of the substitution of the Second proviso to Section 92C(2) of the Income-tax Act by the Finance (No.2) Act, 2009, the second ground of appeal filed by the Revenue may have to be allowed. Consequently it is held that if the difference between the arithmetic mean of the profit margins comparable companies ultimately retained and the profit margin of the Assessee is more than 5% than no deduction under the proviso to Sec.92C(2) of the Act could be allowed to an Assessee. In the light of the decision of Trilogy EBusiness Software India Pvt. Ltd. 2013 (1) TMI 672 - ITAT BANGALORE we hold that igate Global solutions Ltd., Flextronics Software Systems Ltd. And L & T Infotech Ltd would have to be excluded as comparable companies as these companies have turnover above ₹ 200 Crores. So also Tata Elxsi Ltd., would have to be excluded as not comparable in the light of the decision in the case of Logica Pvt. Ltd. (2015 (3) TMI 401 - ITAT BANGALORE). Sankhya Infotech Limited ( Sankhya ) cannot be regarded as a comparable Sankhya is engaged in the business of development of software products & services and training. The company focuses on the development of niche products for the transport and aviation industry. However, segmental information in relation to the above mentioned activities is not available in public domain. Therefore, as Sankhya engages itself in products and services as well as software training, it cannot be considered as a comparable of the Appellant. Melstar Information Technologies Ltd. (Melstar) is functionally comparable to the assessee and clears all the filters applied by the TPO, the same should be considered as comparable with Net Cost Plus margin of 3.26%.The extraordinary item of expenditure, if removed, would render this company as a company revenues of which are not diminishing. Melstar therefore deserves to be included as a comparable company. Adjustment for depreciation - Held that - It would be just and appropriate to remand the issue to the AO for fresh consideration in the light of the decision of Honeywell Technology Solutions Lab P. Ltd. 2013 (9) TMI 189 - ITAT BANGALORE . We are also of the view that the Assessee should be directed to give the quantification of adjustment to be allowed, if found eligible, applying the ratio laid down in the case of 24/7 customercare.com 2013 (1) TMI 45 - ITAT BANGALORE . We hold and direct accordingly. Arithmetic mean of the comparables retained would be within the range of /- 5% of the Assessee s Net Margin accepted.

Summary

Issues Involved:
1. Addition to total income due to determination of Arm's Length Price (ALP) in respect of international transactions.
2. Rejection of comparable companies by CIT(A).
3. Application of Related Party Transaction (RPT) filter.
4. Standard deduction of 5% from the ALP.
5. Inclusion and exclusion of specific comparable companies.
6. Adjustment for depreciation.

Detailed Analysis:

1. Addition to Total Income Due to Determination of ALP:
The core issue in these appeals revolves around the addition made to the total income due to the determination of the Arm's Length Price (ALP) for international transactions between the assessee and its Associated Enterprises (AE). The Transfer Pricing Officer (TPO) determined an ALP resulting in a transfer pricing adjustment of Rs. 9,16,77,074, which was later reduced to Rs. 3,36,89,845 by the CIT(A).

2. Rejection of Comparable Companies by CIT(A):
The CIT(A) rejected several companies from the TPO's list of comparables based on various grounds:
- Abnormal Profits: Companies like Exensys Software Solutions Ltd. and Thirdware Solutions Ltd. were excluded due to abnormal profits.
- Non-Reliability of Financial Data: Satyam Computer Services Ltd. was rejected.
- High Turnover and High Risk: Infosys Technologies was excluded.
- Related Party Transactions (RPT) Filter: Nine companies were rejected for having related party transactions.

3. Application of Related Party Transaction (RPT) Filter:
The Tribunal held that the CIT(A) should have adopted a threshold limit of 15% for RPT, allowing comparables with RPT up to 15% of total revenues. Consequently, the CIT(A)'s exclusion of companies based on a zero percent RPT filter was deemed incorrect.

4. Standard Deduction of 5% from the ALP:
The Tribunal noted that due to the substitution of the Second proviso to Section 92C(2) by the Finance (No.2) Act, 2009, if the difference between the arithmetic mean of the profit margins of comparable companies and the profit margin of the assessee is more than 5%, then no deduction under the proviso to Sec. 92C(2) could be allowed.

5. Inclusion and Exclusion of Specific Comparable Companies:
- Inclusion: The Tribunal included Melstar Information Technologies Ltd. as a comparable, noting that it passed all filters applied by the TPO and was functionally comparable.
- Exclusion: Sankhya Infotech Limited was excluded due to its engagement in diverse activities, including software products and training, making it incomparable. Additionally, companies like iGate Global Solutions Ltd., Flextronics Software Systems Ltd., and L&T Infotech Ltd. were excluded due to turnover above Rs. 200 crores, and Tata Elxsi Ltd. was excluded for functional dissimilarity.

6. Adjustment for Depreciation:
The Tribunal acknowledged the need for adjustments due to differences in depreciation policies between the assessee and comparable companies. The assessee's higher depreciation rates necessitated adjustments to ensure comparability. The Tribunal remanded the issue back to the AO for fresh consideration, directing the assessee to provide quantification of the necessary adjustments.

Conclusion:
The Tribunal allowed the appeals of both the assessee and the Revenue partly. It directed the AO to reconsider the issues related to RPT filter application, standard deduction, and depreciation adjustments. The Tribunal's decision emphasized the need for accurate comparability analysis and adjustments to reflect true economic conditions. The appeals were disposed of with directions for further proceedings in line with the Tribunal's observations.