2015 (5) TMI 367 - AT - Income Tax

Transfer pricing adjustment - Computation of Arms Length Price - wrong selection of comparables - Held that - Kals Information Systems Ltd., Accel Transmatics Ltd., Lucid Software Ltd. and Tata Elxsi Ltd. held to be not comparable with a company engaged in the provision of software development services such as the assessee. Megasoft Ltd. in the list of final comparables chosen by the TPO is concerned, this Tribunal in the case of Trilogy E-Business Software India Pvt. Ltd. 2013 (1) TMI 672 - ITAT BANGALORE has held had held that only segmental data of the said company should be taken for the purpose of comparison. Adjustment on account of ALP and consequent addition made by the AO to the total income, both in the IT segment with the 10 remaining comparable companies (including segmental margin of Megasoft Ltd.) would be 10.89% after working capital adjustment. The same is given as ANNEXURE-II to this order. The said arithmetic mean of the comparables is within the ( ) (-) 5% range contemplated by the second proviso to Sec.92C(2) and consequently no addition by way of adjustment to ALP can be made. We have already seen that the adjustment to ALP and consequent addition to the total income in ITES segment cannot be sustained. - Decided partly in favour of assessee.

Issues Involved:
1. Selection of comparables for determining the Arm's Length Price (ALP) in software development services.
2. Application of the Transactional Net Margin Method (TNMM).
3. Compliance with the Tribunal's directions regarding the selection of comparables and providing the assessee the opportunity to cross-examine parties.
4. Determination of ALP and necessary adjustments under Section 92CA of the Income Tax Act.

Detailed Analysis:

1. Selection of Comparables for Determining ALP:
The primary issue involved the selection of comparable companies to determine the ALP for the software development services provided by the assessee to its Associated Enterprise (AE). Initially, the assessee selected 49 comparables using the TNMM. However, the Transfer Pricing Officer (TPO) rejected many of these and selected 20 comparables, which was later reduced to 14 after applying the Tribunal's directions. The Tribunal noted that the TPO had incorrectly computed the ALP and emphasized the need to adhere to the Tribunal's earlier directions, which included considering only those comparables with turnovers between Rs. 1 crore and Rs. 200 crores.

2. Application of the Transactional Net Margin Method (TNMM):
The TNMM was adopted as the most appropriate method for arriving at the ALP. The TPO determined the arithmetic mean of the profit margin of the comparables to be 20.68%, which was adjusted to 19.13% after considering the working capital adjustment. This method was scrutinized and recalculated as per the Tribunal's directions, resulting in a final adjusted mean of 18.63%.

3. Compliance with Tribunal's Directions:
The Tribunal had earlier directed the TPO to ensure that the operating revenue and cost related to transactions with AEs were accurately considered, and to apply the turnover filter correctly. The Tribunal also directed the TPO to provide the assessee with information obtained under Section 133(6) and allow cross-examination of the parties from whom the information was gathered. The TPO argued that cross-examination was not feasible as the information was collected under verification, not examination. However, the Tribunal found that the TPO did not fully comply with these directions, especially regarding the exclusion of certain comparables.

4. Determination of ALP and Necessary Adjustments:
The Tribunal found that the TPO had included certain companies as comparables which were not functionally similar to the assessee. Specifically, it was noted that companies like KALS Infosystems Ltd., Accel Transmatics Ltd., Lucid Software Ltd., and Tata Elxsi Ltd. were not comparable to the assessee's software development services. The Tribunal cited previous decisions where these companies were excluded as comparables for similar reasons. Additionally, for Megasoft Ltd., only the segmental data related to software services was considered appropriate for comparison.

Conclusion:
The Tribunal concluded that after excluding the non-comparable companies and considering the segmental data of Megasoft Ltd., the arithmetic mean of the remaining comparables was within the +/- 5% range of the assessee's profit margin. Consequently, no adjustment to the ALP was required, and the appeal of the assessee was partly allowed. The Tribunal emphasized the importance of adhering to its directions and ensuring the comparables used are functionally similar to the assessee's operations.

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