2015 (7) TMI 124 - AT - Income Tax

Transfer pricing adjustmeent - arm s length price of the international transactions representing software development services provided to the associated enterprises (AE) is determined by applying transactional net margin method (TNMM) - selection of comparable - Held that - Since the assessee company is engaged in software development services; whereas M/s. Bodhtree Consulting Ltd. was engaged into software product development, we find force in the argument of the ld counsel for the assessee that M/s. Bodhtree Consulting Ltd. is functionally different from assessee company. A captive unit of a comparable company which assumed only a limited risk cannot be compared with a giant company in the area of development of software who assumes all types of risks leading to higher profits. The facts of the appellant are akin and therefore, do not warrant any different conclusion. The appellant is also captive service provider to its AE and as such, M/s. Infosys Ltd. is not a valid comparable with the appellant. M/S THIRDWARE SOLUTIONS assessee is not having any license sale of its products and, the annual report of the Thirdware does not reveal the bifurcation of sale of ₹ 47 crores and ₹ 16 cores from SEZ of STPI Unit. Therefore we direct the exclusion of this company from the list of comparables. SONATA SOFTWARE - In the instant case, aggregate related party transactions are roughly around 95 crores which is approximately about 40% of the total service income of ₹ 243.57 crores.As such, the said comparable is not a valid comparable and hence is directed to be excluded as it fails the RTP filter of 25% applied by the TPO. Mindtree - we direct in the interest of justice that this fact may be taken into account to adjudicate whether this event of amalgamation will effect in treating this company as a comparable to the assessee company. The precedents relied upon on by the learned counsel for the assessee may be taken into account before the TPO decides whether to include the company as comparable or not. Kals Information System should not be regarded as a comparable as this company was developing software products and not purely or mainly software development service provider. Treatment of foreign exchange fluctuation gain/loss as operating item - Held that - As relying on Westfalia Separator India Pvt. Ltd. vs. ACIT 2015 (3) TMI 140 - ITAT DELHI the forex gain or loss is the difference between the price at which an import or export transaction was recorded in the books of account on the basis of rate of foreign exchange then prevailing and the amount actually paid or received at the rate of foreign exchange prevailing at the time of actual payment or receipt. Since such forex loss or gain is a direct outcome of the purchase or sale transaction, it partakes of the same character as that of the transaction to which it relates. When we read the ratio of the case of Sutlej Cotton (1978 (9) TMI 1 - SUPREME Court) in juxtaposition to that of the Special Bench in case of Prakash I Shah (2008 (8) TMI 387 - ITAT BOMBAY-K ), there remains no doubt that forex gain or loss from a trading transaction is not only an item of revenue nature, but is, in fact, a part of the price of import or value of export transaction, as the case may be. Thus we direct the AO/TPO to treat the foreign exchange gain/loss as an operating item - Decided in favour of assessee.

Issues Involved:
1. Transfer pricing addition.
2. Reference to Transfer Pricing Officer (TPO).
3. Rejection of Transfer Pricing Study.
4. Application of filters by TPO.
5. Selection of comparable companies.
6. Risk adjustment.
7. Penalty proceedings under Section 271(l)(c).

Detailed Analysis:

1. Transfer Pricing Addition:
The Assessing Officer (AO) assessed the total income of the appellant at Rs. 19,14,56,510/- against the returned income of Rs. 9,90,640/- after making a transfer pricing addition of Rs. 19,04,65,871/- for software development and maintenance services rendered to its parent company, Fiserv Global Services Inc., USA.

2. Reference to TPO:
The AO referred the international transaction to the TPO without recording reasons for considering it necessary or expedient, which was challenged by the appellant.

3. Rejection of Transfer Pricing Study:
The AO and Dispute Resolution Panel (DRP) erred in confirming the TPO's action in rejecting the appellant's Transfer Pricing Study and conducting a fresh benchmarking analysis based on conjectures and surmises.

4. Application of Filters by TPO:
The AO and DRP confirmed the TPO's application of various filters, including:
- Use of only current year data.
- Rejecting companies with different financial years.
- Rejecting companies with turnover below Rs. 1 crore without an upper filter.
- Rejecting companies with export revenues less than 75% of operating revenues.
- Rejecting companies with related party transactions exceeding 25%.
- Rejecting companies with employee costs less than 25% of total operating costs.
- Rejecting companies with diminishing revenue/persistent losses.

5. Selection of Comparable Companies:
The appellant contested the inclusion of certain companies as comparables:
- Bodhtree Consulting Ltd.: Excluded due to abnormally high increasing sales/profitability and functional differences.
- Infosys Ltd.: Excluded due to its giant stature, brand value, and significant intangibles, making it incomparable with the appellant.
- Thirdware Solutions: Excluded due to functional differences, product/license sales, and significant related party transactions.
- Sonata Software: Excluded due to product sales, significant related party transactions, and extraordinary events like setting up a subsidiary in Dubai.
- Mindtree Ltd.: Remanded to TPO for reconsideration due to extraordinary events like acquisition and amalgamation.
- Kals Information Systems: Excluded due to functional differences and involvement in product development.

6. Risk Adjustment:
The AO and DRP erred in not allowing the risk adjustment claimed by the appellant under Rule 10B(1)(e) read with Rule 10B(3) of the Income Tax Rules, 1962.

7. Penalty Proceedings under Section 271(l)(c):
The AO/TPO erred in mechanically initiating penalty proceedings without recording adequate satisfaction for such initiation.

Treatment of Foreign Exchange Fluctuation:
The foreign exchange fluctuation gain/loss is to be treated as an operating item, as it is an integral part of the sale proceeds for companies engaged in export business.

Conclusion:
The appeal is allowed with directions to the AO/TPO to recompute the arm's length price of the international transaction, excluding the contested comparables and treating foreign exchange fluctuation as an operating item.

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