2017 (3) TMI 86 - AT - Income Tax

Transfer pricing adjustment - ALP determination - contract termination fee inclusion - Held that - assessee has entered into a contract for rendering software development services to its group companies and one of the group company has terminated the contract and has paid the contract termination fee as per the agreement. The nature of the said contract termination fee is, in our opinion, operating revenue. On execution of a contract, the assessee is receiving the consideration on a cost plus margin basis. The contract termination fee is also being paid on similar lines but proportionately. It is only that the contract is being terminated prematurely. Had the contract been executed completely, the assessee would have received the full consideration at cost plus method for the entire period of the contract and it would form part of operating income. The contract termination fee is in effect compensating the assessee for the expenses incurred by it for executing the contract partially. Therefore, we are of the opinion that the contract termination fee also partakes the character of the contract receipt and is to be treated as operating revenue of the international transactions more particularly since the expenses incurred by the assessee on such contract has been taken as operating cost. In view of the same, we direct the AO/TPO to consider the contract termination fee also as a part of the operational income for computing the ALP of the international transactions.

Issues Involved:
1. Rejection of Transfer Pricing (TP) documentation.
2. Use of single year data versus multiple year data.
3. Application of additional filters in the comparative analysis.
4. Selection and rejection of comparable companies.
5. Treatment of contract termination fees.
6. Computation of net margins of selected comparables.
7. Adjustment for risk differences.
8. Applicability of the proviso to Section 92C(2).
9. Levy of interest under Section 234B.
10. Initiation of penalty proceedings under Section 271(1)(c).

Detailed Analysis:

1. Rejection of Transfer Pricing Documentation:
The assessee's TP documentation was rejected by the AO/TPO, leading to an adjustment of ?4,72,33,317. The Tribunal upheld this rejection, stating that the methodology and comparables used by the assessee were not appropriate.

2. Use of Single Year Data versus Multiple Year Data:
The assessee argued for the use of multiple year data to determine the arm's length price, but the AO/TPO used single year data. The Tribunal upheld the use of single year data, consistent with previous decisions.

3. Application of Additional Filters in the Comparative Analysis:
The AO/TPO applied additional filters such as diminishing revenue, persistent losses, different financial year-end, and export sales less than 75% of sales. The Tribunal upheld these filters, rejecting the assessee's objections.

4. Selection and Rejection of Comparable Companies:
The Tribunal addressed the inclusion and exclusion of specific comparable companies:
- Inclusion of Companies:
- Comp-U-Learn Tech India Ltd: The assessee did not pursue its exclusion, so the ground was rejected.
- E Infochips Bangalore Ltd: Excluded due to functional differences and lack of segmental information.
- Kals Information Systems Ltd: Excluded as it was engaged in software products, not just services.
- Tata Elxsi Ltd (Seg): Excluded due to its specialized services and lack of segmental data.
- Rejection of Companies:
- Akshay Software Technologies Ltd, CG-VAK Software Exports Ltd, Satyam Computers Services Ltd: The Tribunal did not adjudicate these as the inclusion of contract termination fees and exclusion of certain companies brought the assessee within the ±5% range.

5. Treatment of Contract Termination Fees:
The Tribunal held that contract termination fees should be considered as part of the operating revenue. This was based on the nature of the fees compensating for services rendered under a cost-plus margin basis.

6. Computation of Net Margins of Selected Comparables:
The Tribunal did not need to adjudicate specific errors in margin computation as the inclusion of contract termination fees and exclusion of certain companies resolved the ALP adjustment issue.

7. Adjustment for Risk Differences:
The Tribunal did not address this issue directly, as the resolution of other grounds made it unnecessary.

8. Applicability of Proviso to Section 92C(2):
The Tribunal did not address this issue directly, as the resolution of other grounds made it unnecessary.

9. Levy of Interest under Section 234B:
The Tribunal directed the AO to provide consequential relief regarding the levy of interest under Section 234B.

10. Initiation of Penalty Proceedings under Section 271(1)(c):
The Tribunal deemed this ground as premature and rejected it.

Separate Judgments:
The Tribunal's decision was consistent across both the assessee's appeal and the Revenue's appeal. The Revenue's appeal against the exclusion of L&T Infotech Ltd was dismissed, as the Tribunal upheld the DRP's decision to exclude it based on functional differences and lack of segmental data. The cross-objection by the assessee was dismissed as it supported the DRP's order.

Conclusion:
The assessee's appeal was partly allowed, resulting in the inclusion of contract termination fees as operating revenue and the exclusion of certain comparables. The Revenue's appeal and the assessee's cross-objection were dismissed.

← Previous Next →