2019 (11) TMI 91 - AT - Income Tax

TP Adjustment - Whether international transactions undertaken by the appellant do not satisfy the arm s length principle envisaged under the Income-tax Act 1961 Act? - TPO applied minimum threshhold limit of 25% export earning from Software Development Services wherein companies whose export revenues from Software Development Services are less than 25% of the operating revenues were excluded - HELD THAT - Appellant is mainly an export oriented software development provider thus companies functionally dissimilar with that of assessee need to be deselected from final list. Act does not provide directions as to what percentage RPT transaction have material effect on the overall margins. In the definition of the Associated Enterprises in section 92A(2)(a), it is provided that one enterprise holding 26% shares in other enterprise can be considered as an AE. Similarly, u/s 40A(2b) of the Act, it is provided that persons having substantial interest is a person carrying not less than 20% of voting power in that company. Keeping these provisions in mind, we are of the view that the filter of 25% applied by the TPO is apt.

Issues Involved:
1. Confirmation of addition to income based on Transfer Pricing adjustments.
2. Selection of comparables for benchmarking international transactions.
3. Filters adopted by the Transfer Pricing Officer (TPO).
4. Inclusion and exclusion of specific companies as comparables.

Detailed Analysis:

1. Confirmation of Addition to Income Based on Transfer Pricing Adjustments:
The appellant, a joint venture providing customized software, reported various international transactions with its Associated Enterprises (AEs) and used the Transactional Net Margin Method (TNMM) for benchmarking. The TPO rejected the appellant’s economic analysis and made a Transfer Pricing (TP) adjustment of ?31,345,467. The Dispute Resolution Panel (DRP) confirmed the proposed additions, leading to the present appeal.

2. Selection of Comparables for Benchmarking International Transactions:
The appellant used 16 comparables with a mean margin of 9.66%, while the TPO selected 26 comparables with a mean margin of 25.16%. The appellant challenged the inclusion of 17 comparables and the use of data obtained under section 133(6) of the Income-tax Act without being given an opportunity to present arguments.

3. Filters Adopted by the Transfer Pricing Officer (TPO):
The TPO applied several filters, including:
- Single-year data (F.Y. 2006-07).
- Income from software development services constituting at least 75% of total operating income.
- No specific impact of R&D expenses on the functionality of a software developer.
- Exclusion of companies with operating sales less than ?1 crore.
- Exclusion of companies with related party transactions exceeding 25% of operating revenues.
- Minimum threshold of 25% export earnings from software development services.
- Exclusion of companies with diminishing revenue over the last three years.

4. Inclusion and Exclusion of Specific Companies as Comparables:
I. Accel Transmatic Limited (Seg):
The company was included as a comparable despite objections regarding related party transactions (RPT) of 19.29%. The TPO's filter of 25% RPT was deemed appropriate.

II. Avani Cimcon Technologies Limited:
Excluded due to owning software products, making it functionally dissimilar to the appellant.

III. Celestial Labs Limited:
Excluded due to its engagement in extensive research activities for developing software for drug discovery, making it functionally dissimilar.

IV. E-Zest Solutions Limited:
Excluded due to lack of segmental information and inadequate details from the TPO.

V. Flextronics Software System (Seg):
Restored to the TPO for re-evaluation due to non-alignment of financial periods.

VI. Helios & Matheson Information Technology Limited:
Excluded due to failing the employee cost to sales filter.

VII. Infosys Technologies Limited:
Excluded due to substantial intangible assets, brand value, and significantly higher turnover compared to the appellant.

VIII. Ishir Infotech Limited:
Excluded due to failing the employee cost filter.

IX. KALS Information Systems Limited:
Included as it met the filters and provided sufficient segmental information.

X. Lucid Software Limited:
Excluded due to engagement in product development and lack of segmental information.

XI. Megasoft Solutions:
Excluded due to extraordinary events during the year and different accounting periods.

XII. Persistent Systems Private Limited:
Included as it met all filters despite objections regarding functional dissimilarity.

XIII. R Systems International Limited:
Restored to the TPO for re-evaluation due to non-alignment of financial periods.

XIV. Sasken Communication Technologies Ltd:
Excluded due to restructuring during the year.

XV. Tata Elxsi Limited:
Excluded due to diversified business operations and lack of segmental accounts.

XVI. Thirdware Solutions Limited:
Excluded due to lack of segmental accounts and insufficient data for comparison.

XVII. Wipro Limited:
Excluded due to its global status, high brand value, and diversified activities.

XVIII. Computed International Limited & XIX. Melstar Information Technologies Limited:
Restored to the TPO for re-evaluation after confronting the information gathered under section 133(6) with the appellant.

Conclusion:
The appeal was partly allowed, with several companies directed to be excluded from the final set of comparables, and some issues restored to the TPO for re-evaluation. The judgment emphasized the need for a detailed and fair assessment of comparables based on functional similarity and appropriate filters.

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