2015 (3) TMI 937 - AT - Income Tax

Transfer pricing adjustment - addition made to the total income consequent to determination of Arm s Length Price - 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 and Sony India Private Ltd. 2008 (9) TMI 420 - ITAT DELHI-H as taken a view that comparables having RPT of upto 15% of total revenues can be considered. In view thereof, the Revenue s grievance on this issue as projected in 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. Selection of comparable - CIT(A) holding that profit on cost of more than 50% of the comparable company(ies) is abnormal - Held that - The filter of companies dealing in software products and abnormal profits owing to amalgamation of the companies during the relevant period thereby showing abnormal profits was applied to exclude Exensys Software solutions Ltd. Infosys Technologies Ltd., was excluded for reasons of high turnover and high risk profile. Satyam Computer Services Ltd., has to be excluded from the comparable companies for non-reliability of financial data as it was involved in financial scam. Standard deduction of 5% of the arm s length price allowed to the Appellant by the CIT(A) - 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. Although 12 comparable which were rejected on the basis of RPT being more than zero percent, one comparable viz., Four Soft Ltd., will have to be excluded since the RPT is at 19.89% and thus in excess of 15%. Sathyam Computers Ltd., and Infosys Technologies Ltd., will get excluded for the reason that the financial results are not reliable in the case of Sathyam Computers Ltd., and for the reason that the high turnover, brand value, high risks etc. The remaining 9 comparable companies which were excluded by the CIT(A) by applying the Related Party Transaction filter of 0% related party transaction will now have to be included. Also Foursoft Ltd., and Thirdware Solutions Ltd., should be excluded from the list of comparable companies. TATA Elxsi Ltd., should also be excluded from the list of comparable companies as is not functionally comparable with that of a software development service provider such as the Assessee. Appeal by the Revenue and the cross objection by the assessee is partly allowed.

Issues Involved:
1. Addition to total income due to determination of Arm's Length Price (ALP) for international transactions.
2. Application of filters for choosing comparable companies.
3. Exclusion of specific comparable companies based on different criteria.
4. Standard deduction under the proviso to Section 92C(2) of the Income Tax Act, 1961.

Detailed Analysis:

1. Addition to Total Income due to Determination of ALP:
The primary issue in the appeal by the Revenue and the cross-objection by the Assessee pertains to the addition made to the total income following the determination of Arm's Length Price (ALP) for international transactions under Section 92 of the Income Tax Act, 1961. The Transfer Pricing Officer (TPO) had determined an ALP resulting in an addition of Rs. 1,00,84,613 to the Assessee's total income. The CIT(A) gave partial relief to the Assessee, leading to appeals from both the Revenue and the Assessee.

2. Application of Filters for Choosing Comparable Companies:
The CIT(A) excluded 12 out of 17 comparable companies chosen by the TPO due to related party transactions, applying a zero-tolerance filter for such transactions. The Tribunal held that comparables having related party transactions (RPT) up to 15% of total revenues could be considered, thus allowing the Revenue's appeal on this ground.

3. Exclusion of Specific Comparable Companies:
- Exensys Software Solutions Ltd.: Excluded due to involvement in multiple activities and showing supernormal profits due to an amalgamation.
- Satyam Computer Services Ltd.: Excluded for non-reliability of financial data due to involvement in a financial scam.
- Infosys Technologies Ltd.: Excluded based on high turnover and high risk, following the decision in Agnity India Technologies v. ITO.
- Sankhya Infotech Ltd.: Excluded as it engages in both software products and services without segmental information available.
- Four Soft Ltd. and Thirdware Solutions Ltd.: Excluded as they were involved in product development and not purely in software development services.
- TATA Elxsi Ltd.: Excluded due to functional dissimilarity and lack of segmental profits specific to software development services.

4. Standard Deduction under the Proviso to Section 92C(2):
The CIT(A) allowed a 5% standard deduction under the proviso to Section 92C(2) of the Income Tax Act. The Tribunal held that if the difference between the arithmetic mean of the profit margins of comparable companies and the Assessee's profit margin is more than 5%, no deduction under the proviso could be allowed.

Conclusion:
The Tribunal partly allowed the appeal by the Revenue and the cross-objection by the Assessee. The Tribunal directed the inclusion of comparable companies with RPT up to 15% and excluded certain companies based on functional dissimilarity and lack of reliable financial data. The Tribunal also upheld the CIT(A)'s decision regarding the standard deduction under Section 92C(2). The final arithmetic mean of the comparables retained would be within the permissible range, thus addressing the grounds raised by both parties.

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