2020 (4) TMI 776 - AT - Income Tax

TP Adjustment - selection of comparable - HELD THAT - Assessee is into providing software development services, thus companies functionally dissimilar with that of assessee need to be deselected from final list. Operating profit estimation - HELD THAT - Directions of the DRP directing considering foreign exchange fluctuation gain as part of the operating profit of the Assessee is without merit as the law by now is well settled that foreign exchange gain has to be regarded as part of operating profit as held in the case of Electronics for imaging India Pvt.Ltd. Vs. DCIT 2017 (7) TMI 1335 - ITAT BANGALORE . Deduction u/s.10A on the profits derived from its Software Technology Parks of India (STPI) - HELD THAT - Taking into consideration the decision rendered by the Hon ble High Court of Karnataka in the case of CIT v. Tata Elxsi Ltd 2011 (8) TMI 782 - KARNATAKA HIGH COURT we are of the view that the CIT(A) was justified in excluding expenses both from export turnover and total turnover. We are of the view that as of today, law declared by the Hon'ble High Court of Karnataka which is the jurisdictional High Court is binding on us. Moreover, the order of the Hon ble Karnataka High Court has been upheld by the Hon ble Supreme Court in the case of CIT v. HCL Technologies Ltd. 2018 (5) TMI 357 - SUPREME COURT . The grounds are decided accordingly.

Issues Involved:
1. Determination of Arm's Length Price (ALP) for Software Development (SWD) services.
2. Exclusion of certain companies from the list of comparables.
3. Inclusion of foreign exchange fluctuation in operating revenue.
4. Computation of deduction under Section 10A of the Income Tax Act.

Detailed Analysis:

1. Determination of Arm's Length Price (ALP) for Software Development (SWD) services:
The primary issue in the appeal by the Revenue and the Cross Objection (C.O.) by the Assessee was the determination of ALP for the international transaction of rendering SWD services by the Assessee to its Associated Enterprise (AE). The Assessee, a subsidiary of Brocade Communications, Switzerland SARL, provided SWD services to its AE and received ?96,08,41,988/-. The Transfer Pricing Officer (TPO) suggested an addition of ?5,95,55,635/- to the total income of the Assessee after determining the transfer price.

The Assessee's Transfer Pricing Analysis showed an Operating Profit (OP) of ?13,25,29,930/- and an Operating/Net Margin (OP/OC) of 16%. The Assessee selected 12 comparable companies with an arithmetic mean profit margin of 14.43%, which was lower than the Assessee's margin. The TPO, however, rejected the Assessee's study and selected a different set of comparables, arriving at an arithmetic mean margin of 24.82% before working capital adjustment and 22.04% after adjustment.

2. Exclusion of certain companies from the list of comparables:
The Dispute Resolution Panel (DRP) directed the exclusion of several companies, including E-Infochips Ltd., ICRA Techno Analytics Ltd., Infosys Ltd., Larsen & Toubro Infotech Ltd., and Tata Elxsi Ltd., from the list of comparables on the grounds of functional dissimilarity and lack of segmental details. The DRP also rejected companies predominantly engaged in onsite activities, such as L&T Infotech Ltd. and RS Software (India) Ltd.

The Tribunal upheld the DRP's exclusion of ICRA Techno Analytics Ltd., Infosys Ltd., and Tata Elxsi Ltd., following the ITAT Bangalore Bench's decision in the case of M/s Applied Materials India Pvt. Ltd. vs. ACIT. The Tribunal also agreed with the DRP's decision to exclude Persistent Systems Ltd. and Sasken Communication Technologies Ltd. based on the lack of segmental details and functional dissimilarity, as established in the case of Electronics for Imaging India (P) Ltd. vs. DCIT.

3. Inclusion of foreign exchange fluctuation in operating revenue:
The DRP directed the Assessing Officer (AO) to consider the gain/loss from foreign exchange fluctuation as operating in nature while computing the margins of the Assessee and the comparable companies. The Tribunal upheld this direction, noting that the law is well-settled that foreign exchange gain should be regarded as part of operating profit, as held in the case of Electronics for Imaging India Pvt. Ltd. vs. DCIT.

4. Computation of deduction under Section 10A of the Income Tax Act:
The AO excluded travel and communication expenses from the export turnover while computing the deduction under Section 10A, resulting in a lower deduction for the Assessee. The Assessee argued that these expenses should not be excluded from the export turnover and, alternatively, if excluded, should also be excluded from the total turnover. The CIT(A) upheld the Assessee's alternate prayer, following the decision of the Karnataka High Court in the case of CIT v. Tata Elxsi Ltd.

The Tribunal agreed with the CIT(A), emphasizing that the law declared by the Karnataka High Court, which has been upheld by the Supreme Court in the case of CIT v. HCL Technologies Ltd., is binding.

Conclusion:
The Tribunal partly allowed the Revenue's appeal to the extent of including RS Software (India) Ltd. as a comparable company, while dismissing the other grounds raised by the Revenue. The Cross-Objection of the Assessee was also partly allowed, with the exclusion of Persistent Systems Ltd. and Sasken Communication Technologies Ltd. from the list of comparables. The TPO was directed to compute the ALP in light of the Tribunal's directions after affording the Assessee an opportunity of being heard.

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