2015 (7) TMI 125 - AT - Income Tax

Transfer pricing adjustment - selection of comparable - Held that - For M/s E-Infochips Bangalore Ltd. profit margin of such entity in the immediately preceding year(s) may also be taken into consideration and the FAR analysis in such cases may be reviewed to ensure that the potential comparable earning higher profit satisfies the comparability condition. Since this exercise has not been done either by the AO/TPO or the DRP in the present case, we are of the view that the matter should go back to the Assessing Officer/TPO for fresh consideration. See M/s Electronics Arts Games vs. ACIT 2015 (5) TMI 754 - ITAT HYDERABAD INFOSYS LTD 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 PERSISTENT SYSTEMS LTD should not be regarded as a comparable as relying on Agnity Technologies case 2010 (11) TMI 852 - ITAT DELHI 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. Non-compliance with Section 144C(13) by the Assessing Officer (AO).
2. Addition of Rs. 28,59,06,323/- to the income of the appellant.
3. Reference to the Transfer Pricing Officer (TPO) without recording reasons.
4. Partial confirmation of TPO's action by AO and Dispute Resolution Panel (DRP).
5. Rejection of Transfer Pricing Study (TP Study) by TPO.
6. Application of specific filters by TPO.
7. Rejection of comparable companies selected by the appellant.
8. Selection of non-comparable companies by TPO.
9. Selection of E-Infochips Bangalore Ltd. as a comparable.
10. Selection of Persistent Systems Ltd. as a comparable.
11. Treatment of foreign exchange gain/loss and hedging costs/premium.
12. Non-allowance of risk adjustment.
13. Adjustment to arm's length price without considering Section 10A deduction.
14. Initiation of penalty proceedings under Section 271(1)(c).
15. Charging of interest under Sections 234B and 234D.

Issue-wise Detailed Analysis:

1. Non-compliance with Section 144C(13) by AO:
The appellant argued that the final assessment order dated 14.11.2014 was not in conformity with the binding and mandatory directions issued by the DRP, rendering the order illegal and bad in law.

2. Addition of Rs. 28,59,06,323/- to Income:
The AO made an addition of Rs. 28,59,06,323/- to the appellant's income concerning international transactions of software development and maintenance services rendered to its parent company, Fiserv Global Services Inc., USA. The appellant contended that the DRP had allowed substantial relief on this issue.

3. Reference to TPO without Recording Reasons:
The appellant argued that the AO made a reference to the TPO under Section 92CA of the Act without recording reasons, which is necessary to consider the international transaction entered into by the appellant with its associated enterprise (AE).

4. Partial Confirmation by AO and DRP:
The AO and DRP erred in partly confirming the action of the TPO without appreciating that the appellant had computed the arm's length price using the most appropriate method (TNMM) and maintained all required documentation.

5. Rejection of Transfer Pricing Study:
The AO and DRP confirmed the TPO's action in rejecting the appellant's TP Study and conducting a fresh benchmarking analysis based on conjectures and surmises.

6. Application of Specific Filters:
The AO and DRP confirmed the TPO's application of the following filters:
- Use of only current year data for comparability.
- Rejecting companies with turnover below Rs. 5 crores without applying an upper filter of Rs. 500 crores.
- Rejecting companies whose revenues from services are less than 75% of total operating revenues.
- Rejecting companies where revenue from related party transactions exceeds 25% of total revenue.
- Rejecting companies with employee costs less than 25% of total operating costs.
- Rejecting companies with different financial years without assigning cogent reasons.

7. Rejection of Comparable Companies:
The AO and DRP erred in rejecting the comparable companies selected by the appellant without providing sufficient reasoning.

8. Selection of Non-comparable Companies:
The AO and DRP erred in selecting companies that were not functionally comparable to the appellant, including E-Infochips Bangalore Ltd., Infosys Ltd., and Persistent Systems Ltd.

9. Selection of E-Infochips Bangalore Ltd.:
The DRP repelled the objection of the assessee, stating that E-Infochips Bangalore Ltd. was involved in product lifecycle management, application development, and enterprise IT consulting, making it comparable. However, the appellant contended that the company provided complex product development services and lacked segmental information, making it non-comparable. The Tribunal agreed with the appellant and set aside the orders of TPO/DRP for a de novo examination.

10. Selection of Persistent Systems Ltd.:
The appellant argued that Persistent Systems Ltd. was functionally different and involved in diversified activities, including software products, making it non-comparable. The Tribunal agreed, citing previous decisions that companies with high turnover and diversified activities are not comparable to smaller, captive service providers.

11. Treatment of Foreign Exchange Gain/Loss:
The appellant contended that foreign exchange gain/loss should be treated as an operating item. The Tribunal agreed, citing previous decisions that foreign exchange fluctuations are integral to the sale proceeds of export businesses and should be included in the computation of operating margins.

12. Non-allowance of 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.

13. Adjustment to Arm's Length Price:
The TPO and DRP erred in proposing an adjustment to the arm's length price without considering that the appellant was eligible to claim a deduction under Section 10A of the Act, which negates any motive to shift profits outside India.

14. Initiation of Penalty Proceedings:
The DRP erred in confirming the action of the AO/TPO in mechanically initiating penalty proceedings under Section 271(1)(c) of the Act.

15. Charging of Interest:
The AO erred in charging interest under Sections 234B and 234D of the Act, violating the provisions of the Act.

Conclusion:
The Tribunal allowed the appeal, directing the AO/TPO to compute the arm's length price of the international transaction entered into by the assessee with its AE, keeping in view the observations made. The Tribunal set aside the orders of TPO/DRP for a de novo examination concerning the selection of E-Infochips Bangalore Ltd., Infosys Ltd., and Persistent Systems Ltd. The Tribunal also directed the AO/TPO to treat the foreign exchange gain/loss as an operating item.

← Previous Next →