2019 (2) TMI 227 - AT - Income Tax

TPA - comparable selection - application Related Party Transaction (RPT) filter i.e. excluded companies which had transactions with related parties - Held that - Application of RPT filer at 15% of the sales would be appropriate in the given facts and circumstances of the case and as laid down in the case of Auto Desk India Pvt. Ltd. 2018 (7) TMI 1862 - ITAT BANGALORE , we hold accordingly and direct to inclusion of 3 companies which were excluded by application of RPT Filter by the DRP. Assessee is a pure software development services company thus companies functionally dissimilar with that of assessee need to be deselected from final list. Interest on Sundry debtors outstanding for more than 3 months - Held that - The plea of the assessee has to be accepted as held by the Bangalore Bench in the case of Avnet India Pvt. Ltd., 2016 (1) TMI 410 - ITAT BANGALORE that giving a credit period cannot be considered as an independent transaction. It is a integral part of transaction of rendering of software development services by the assessee to its AE and has to be considered as part of the international transaction of Software Development Services. The decision of Mumbai Bench of Tribunal in the case of Goldstar Jewellery Ltd., Vs. JCIT 2015 (2) TMI 58 - ITAT MUMBAI . URO supports the plea of the assessee. Following the aforesaid decision, we hold that there can be no separate determination of ALP of international transaction of realization of sale proceeds with extended credit period as it is only incidental to transaction of sale. The addition made by the TPO and confirmed by the DRP cannot be sustained and the same is directed to be deleted. Disallowance of depreciation on software expenses under section 40(a)(ia) read with section 194J - Held that - As decided in M/S. WINTAC LIMITED VERSUS DEPUTY COMMISSIONER OF INCOME-TAX, CENTRAL CIRCLE 12 (5) , BENGALURU 2017 (4) TMI 819 - ITAT BANGALORE once the assessee has capitalized the payment in question though the assessee has not deducted the tax at source on such payment, Section 40(a)(i) cannot be invoked for disallowance of depreciation. Accordingly, we set aside the orders of the authorities below and the addition made by the AO is deleted.

Summary

Issues Involved:
1. Determination of Arm's Length Price (ALP) in respect of international transactions.
2. Application of the Related Party Transaction (RPT) filter.
3. Inclusion and exclusion of specific comparable companies.
4. Recharacterization of outstanding debtors as loans and computation of notional interest.
5. Disallowance of depreciation on software expenses under section 40(a)(ia) read with section 194J of the Income-tax Act.

Issue-wise Detailed Analysis:

1. Determination of Arm's Length Price (ALP):
The assessee, engaged in software development services, entered into international transactions with its Associated Enterprise (AE). The assessee reported an Operating Profit on Cost (OP/OC) of 12.60%. The Transfer Pricing Officer (TPO) accepted 7 out of 21 comparable companies selected by the assessee and added 4 more, resulting in an average margin of 22.71%. This led to an adjustment of ?1,69,02,386 to the total income of the assessee.

2. Application of the Related Party Transaction (RPT) Filter:
The Dispute Resolution Panel (DRP) applied a 0% RPT filter, excluding companies with any related party transactions. The assessee argued for a 15% threshold, referencing the Bangalore ITAT's decision in its own case for AY 2005-06. The Tribunal agreed with the assessee, directing the inclusion of companies with RPT below 15%.

3. Inclusion and Exclusion of Specific Comparable Companies:
The DRP excluded companies with turnover exceeding ?200 crores, which included Infosys Ltd., L&T Infotech Ltd., Mind Tree, Persistent Systems Pvt. Ltd., Tata Elxsi Ltd., and Sasken Communication Technologies Ltd. The Tribunal upheld the inclusion of companies with RPT below 15%, directing the TPO to re-examine Kals Information Systems Ltd. for functional comparability.

4. Recharacterization of Outstanding Debtors as Loans:
The TPO treated extended credit periods to AE as loans, computing notional interest of ?52,73,325 at an 11.25% interest rate. The Tribunal, citing the Bangalore ITAT's decision in Avnet India Pvt. Ltd., held that allowing credit periods is integral to the main transaction and cannot be considered a separate international transaction. Consequently, the addition made by the TPO was deleted.

5. Disallowance of Depreciation on Software Expenses:
The AO disallowed depreciation on software expenses due to non-deduction of TDS, treating the payment as royalty under section 194J. The Tribunal, referencing the ITAT Bangalore's decision in M/s Wintac Ltd., held that disallowance under section 40(a)(ia) does not apply to capitalized expenses. Therefore, the disallowance was deleted.

Conclusion:
The appeal was partly allowed, with the Tribunal directing the inclusion of certain companies based on the 15% RPT filter, re-examination of Kals Information Systems Ltd., and deletion of additions related to notional interest and depreciation disallowance.