2015 (10) TMI 2431 - AT - Income Tax

Transfer pricing adjustment - selection of comparables - Held that - CAT Technologies Ltd has earned Medical transcription receipts of ₹ 83.74 lac and Training income of ₹ 2.44 lac, both of which have been combined with the income from Software development and consulting services. One cannot ascertain with precision the contribution made by the income from Medical transcription and Training to the overall profitability of CAT Technologies Ltd., so that the other income may be segregated. As such, we fail to comprehend as to how the entity level comparison of this company with the assessee s Software development and maintenance services segment can be construed as valid. This company is, therefore, directed to be excluded from the list of comparables. Infosys Technologies Ltd. considering the giantness of Infosys Ltd., in terms of risk profile, nature of services, number of employees, ownership of branded products and brand related profits, etc. in comparison with the factors prevailing in the case of Agnity India Technologies Pvt. Ltd., being, a captive unit providing software development services without having any IP rights in the work done by it. Tata Elxsi company is also engaged in sale of software products/solutions and has its own intangibles. The revenues under Systems integration and support segment of this company stand at ₹ 4008.75 crore, out of its total revenue of ₹ 41851.60. For comparison, the TPO has taken the figures of this company at entity level, starting with a revenue at ₹ 41851.60 crore. Since the overall profit of this company includes the effect of profit from sale/licensing of software products/solutions and there is no measure to isolate such profit from the overall profit of software development segment, we hold that this company at an entity level cannot be considered as comparable with the assessee s Software development and maintenance segment. This company is, therefore, directed to be excluded. TCS Ltd. - once acquisition and merger etc. has taken place, it is always likely to affect the profitability of such a company in the year of acquisition etc. There cannot be any standard yardstick to measure the impact of such a factor on the overall profitability of such a company. It is relevant to highlight that we are considering the exclusion of a company on this score. In our considered opinion, when other comparables are available, the exclusion of a probable comparable company cannot have much significance in contrast to a situation of inclusion of a probable incomparable. We hold that TCS Ltd. cannot be considered as comparable with the assessee s software development and maintenance segment on this count as well. The same is directed to be excluded. Thirdware Solutions Ltd. - It is observed from the Annual report of this company that apart from revenue from Software services , this company has also earned revenue from Sales. The TPO has considered entity level figures of this company for comparison. In view of the joining of the revenue from sales with the revenue from software services, this company ceases to be comparable with the assessee s Software development and maintenance services segment. Here, it is pertinent to mention that this company was considered by the TPO as comparable in the immediately preceding year as well. The Tribunal vide its aforenoted order, has held it to be incomparable. Since no distinguishing features of the functional profile of this company and the assessee for the current year vis- -vis the preceding year have been brought to our notice, following the precedent, we order for the removal of this company from the list of comparables. Quintegra Solutions Ltd. - the Annual report of this company that it has Copyrights included in its Schedule of fixed assets with the closing written down value at ₹ 2.17 crore. Apart from that, it is seen that this company is regularly incurring expenses on Research and development. This company is also earning revenue from sale of software products apart from rendering software services. Following the view taken for the exclusion of Thirdware Solutions Ltd. etc. above, we hold that this company has been rightly excluded from the list of comparables by the TPO because of the joining of its income from sale of products with the income from rendering of software development services. The TPO s action is, therefore, approved. Zylog Systems Ltd. - Though the ld. AR initially argued for recognizing this company as comparable, but after noting the differences in the functional profile of this company with the Software development and maintenance service segment of the assessee, it was fairly conceded that this company was not comparable. Under such circumstances, we approve the view taken by the TPO in excluding it from the list of comparables. Accentia Technologies Ltd. - It has been mentioned that this company Completed the acquisition of Oak Technologies Inc., USA and has rapidly increased its customer base from New Jersey and neighboring areas. This shows that extraordinary financial event happened during the year in this company by means of acquisition, thereby rendering it as unfit for comparison with the assessee s profitability under this segment. Following the view taken hereinabove while discussing the exclusion of TCS Ltd. from the Software Development and Maintenance segment of the assessee, we direct the elimination of this company also from the final list of comparables. Cosmic Global Ltd. - this company was subject matter of consideration by the Tribunal in its order for the immediately preceding assessment year as well. After making a detailed analysis, the Tribunal has approved the view taken by the TPO in considering this company as a fit comparable. Following such a view taken in the immediately preceding assessment year, we uphold the TPO s order rejecting the assessee s contention for exclusion. Coral Hub (Vishal Information Technology Ltd.) coming to the functional comparability of this company, we observe from its Annual report that it is outsourcing its major activities. Such outsourcing charges constitute around 90.57% of the total operating cost. As against this, the assessee is engaged in providing the services under this segment at its own without any outsourcing. This crucial difference between the manner of performing services has an important bearing on the ultimate profitability. The Delhi Bench of the Tribunal in the case of Mercer Consulting (India) Pvt. Ltd. Vs. DCIT 2014 (7) TMI 715 - ITAT DELHI has approved the exclusion of this company from the list of comparables E-Clerx Services Ltd. is engaged in KPO services which cannot be compared with a company providing low-end BPO services. Turning to the facts of the instant case, we find that the segment of the assessee under consideration is Back office support plus F&A services . By no standard, a KPO company like e-Clerx can be considered as comparable with the Back office support plus F&A services segment of the assessee. We, therefore, order for the removal of this company from the list of comparables. Genesis International Corporation Ltd. company is totally incomparable with this segment of the assessee. At this stage, it is further pertinent to mention that the TPO has himself excluded this company from the list of comparables for the immediately succeeding year by noticing it to be a functionally different company. As such, we are not inclined to accept the comparability of this company with the assessee s merged Back office support and F&A support services segment. This company is directed to be taken away from the tally of comparables under this segment. Non reducing lease line charges from total turnover , after excluding it from export turnover - Held that - e find force in the contention advanced by the ld. AR, requiring the exclusion of this amount from total turnover as well. The obvious reason is that when a particular item does not form part of export turnover, which, in turn, is a necessary ingredient of the total turnover, the same has to be necessarily excluded from the computation of latter. It has been brought to our notice that the Tribunal in assessee s own case for the A.Ys. 2007-08 and 2008-09 has decided this issue in assessee s favour.

Summary

Issues Involved:
1. Transfer pricing adjustment for software development and maintenance support services.
2. Transfer pricing adjustment for back office support services and F&A support services.
3. Transfer pricing adjustment for advisory services.
4. Working capital adjustment.
5. Treatment of foreign exchange gain/loss.
6. Exclusion of lease line charges from total turnover for section 10A benefit.

Detailed Analysis:

1. Transfer Pricing Adjustment for Software Development and Maintenance Support Services:
The TPO initially identified 16 companies as comparables, determining an average OP/TC of 28.74%, resulting in a TP adjustment of Rs. 6,38,46,198, which the DRP reduced to Rs. 4,82,48,394. The assessee contested the inclusion of five companies and the exclusion of two. The Tribunal examined the nature of services provided by the assessee, which included software development and maintenance support services. The Tribunal directed the exclusion of CAT Technologies Ltd., Infosys Technologies Ltd., Tata Elxsi, TCS Ltd., and Thirdware Solutions Ltd. from the comparables due to their functional dissimilarities and extraordinary financial events. The non-inclusion of Quintegra Solutions Ltd. and Zylog Systems Ltd. was upheld due to their distinct functional profiles.

2. Transfer Pricing Adjustment for Back Office Support Services and F&A Support Services:
The TPO merged the back office support services and F&A support services segments for benchmarking, resulting in a TP adjustment of Rs. 1.89 crore, reduced to Rs. 1.48 crore by the DRP. The Tribunal upheld the merger and examined the comparability of five companies. Accentia Technologies Ltd. was excluded due to acquisitions and mergers during the year. Cosmic Global Ltd. and Coral Hub (Vishal Information Technology Ltd.) were included as comparables. e-Clerx Services Ltd. was excluded as it was engaged in KPO services, and Genesis International Corporation Ltd. was excluded due to its distinct geospatial services.

3. Transfer Pricing Adjustment for Advisory Services:
The TPO recommended a TP adjustment of Rs. 17,08,751, which the DRP reduced to Rs. 16,04,147. The Tribunal dismissed the ground due to the non-availability of relevant material and evidence from the assessee.

4. Working Capital Adjustment:
The assessee requested a working capital adjustment, which the TPO denied, stating that the assessee did not demonstrate differences in working capital levels compared to comparables. The Tribunal agreed in principle with the grant of working capital adjustment, emphasizing the need to neutralize differences in inventory, trade receivables, and trade payables. The Tribunal directed the AO/TPO to compute and allow the adjustment, if any, for all segments distinctly.

5. Treatment of Foreign Exchange Gain/Loss:
The TPO treated FOREX gain/loss as non-operating. The Tribunal held that FOREX gain/loss related to revenue transactions should be considered as an item of operating nature, both for the assessee and comparables, in line with precedents from various Tribunal decisions.

6. Exclusion of Lease Line Charges from Total Turnover for Section 10A Benefit:
The AO reduced lease line charges from export turnover but did not exclude them from total turnover. The Tribunal, following precedents from earlier years and the Hon'ble High Court's judgment, allowed the exclusion of lease line charges from total turnover, aligning it with the treatment of export turnover.

Conclusion:
The Tribunal set aside the impugned order on the question of transfer pricing adjustments under all segments and directed the AO/TPO to re-determine the ALP afresh, granting the assessee a reasonable opportunity of being heard. The appeal was partly allowed.