2015 (7) TMI 251 - AT - Income Tax

Transfer pricing adjustment - whether foreign exchange fluctuation should be considered as operating item while computing operating profit? - Held that - The issue is no longer res-integra and stands decided in the case of M/s. SSP India Pvt. Ltd. 2015 (7) TMI 214 - ITAT DELHI wherein held that foreign exchange gain/loss should be treated as as an operating item. Rejection of M/s. B2B Software Technologies Limited and M/s. Cressanda Solutions Ltd. as comparables by adopting the filter of the sales turnover less than 5 crore - Held that - No justification for the TPO/DRP to adopt ₹ 5 crore as the threshold turnover for the purpose of a selection of comparable when the assessee which has been adopted as a tested party has a turnover of ₹ 12.50 crores. Once, there is no dispute that two companies selected by the company though having turnover less than 5 crores are functionally comparable with the assessee, the basis adopted to reject the same is not tenable. However, from the order of TPO, it is evident that M/s. B2B Software Technologies Ltd. was also excluded on the ground that it had also failed export filter which filter has not been challenged before us and has been accepted by the taxpayer. Thus, having regard to the above, we direct the inclusion of M/s. Cressanda Solutions Ltd. as a comparable for the purpose of determining the arm‟s length price. - Decided partly in favour of assessee. Tata Elxsi Limited erroneously considered in the final set of comparable companies - Held that - As relying on case of Adaptech India (P) Ltd. vs. ITO 2014 (12) TMI 50 - ITAT HYDERABAD Tata Elxsi is engaged in development of niche product and development services, which is entirely different from the assessee company. We agree with the contention of the learned AR that the nature of product developed and services provided by this company are different from the assessee.Even the segmental details for revenue sales have not been provided by the TPO so as to consider it as a comparable party for comparing the profit ratio from product and services. Thus, on these facts, we are unable to treat this company fit for comparability analysis for determining the arms length price for the assessee, hence, should be excluded from the list of comparable parties - Decided in favour of assessee. Rejection of M/s. CG VAK Software & Exports Limited from final set of comparables as not passing the filter of employee cost to total cost less than 25%. - Held that - As relying on case of Kenexa Technologies Pvt. Ltd. vs. DCIT 2014 (11) TMI 587 - ITAT HYDERABAD we set aside the said issue of comparables with M/s. CG VAK Software & Exports Limited to the TPO for correct application of employee cost filter. - Decided in favour of assessee for statistical purposes.

Issues Involved:
1. Adjustment to the arm's length price of international transactions.
2. Treatment of foreign exchange fluctuation income.
3. Application of turnover filters in the selection of comparable companies.
4. Inclusion/exclusion of specific comparable companies.
5. Allowance of risk adjustment for the appellant.
6. Levy of interest under Sections 234B and 234C of the Act.

Issue-wise Detailed Analysis:

1. Adjustment to the Arm's Length Price of International Transactions:
The appellant challenged the adjustment of Rs. 1,26,14,209 to the arm's length price of software development services provided to its associated enterprise. The appellant used the Transactional Net Margin Method (TNMM) with an operating profit margin (OP/OC) of 7.91%, arguing that this was higher than the average margin of comparable companies at 7.83%. However, the Transfer Pricing Officer (TPO) rejected the appellant's comparables and selected a new set, resulting in a higher margin of 29.45%. The Dispute Resolution Panel (DRP) later reduced this margin to 17.29%, leading to an adjustment of Rs. 1,26,14,209.

2. Treatment of Foreign Exchange Fluctuation Income:
The appellant contended that the DRP/TPO erred in treating foreign exchange fluctuation income as a non-operating item. The appellant argued that such income is integral to its business and should be included in operating income. The tribunal agreed, referencing previous decisions and the OECD Guidelines, and directed the AO/TPO to treat foreign exchange gains/losses as operating items.

3. Application of Turnover Filters in the Selection of Comparable Companies:
The appellant argued against the DRP/TPO's rejection of companies with turnover less than Rs. 5 crore, asserting that these companies were functionally comparable. The tribunal found that the threshold of Rs. 5 crore was unjustified, especially since the appellant's turnover was Rs. 12.50 crore. The tribunal directed the inclusion of M/s. Cressanda Solutions Ltd. as a comparable, but upheld the exclusion of M/s. B2B Software Technologies Ltd. due to its failure to meet the export filter.

4. Inclusion/Exclusion of Specific Comparable Companies:
- Tata Elxsi Ltd.: The appellant argued that Tata Elxsi Ltd. was not comparable due to its high turnover and specialized services. The tribunal agreed, citing previous decisions that excluded Tata Elxsi Ltd. from comparability.
- CG VAK Software & Exports Ltd.: The appellant challenged the exclusion of CG VAK Software & Exports Ltd. based on the employee cost filter. The tribunal directed the TPO to reconsider this company for comparability after correctly applying the employee cost filter.

5. Allowance of Risk Adjustment for the Appellant:
The appellant's grounds for risk adjustment were dismissed as not being pressed during the hearing.

6. Levy of Interest under Sections 234B and 234C of the Act:
The tribunal noted that the issue of interest levy was consequential in nature and would depend on the final determination of the appellant's income.

Conclusion:
The tribunal partly allowed the appeal, directing the inclusion of certain comparable companies and the treatment of foreign exchange gains/losses as operating items, while upholding some of the DRP/TPO's decisions. The tribunal emphasized the need for correct application of filters and comparability standards in transfer pricing assessments.

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