2020 (9) TMI 1093 - AT - Income Tax

TP Adjustment - comparable selection - HELD THAT - Assessee which is a captive software development service provider and renders software development and solutions and ITES to support the global contracts negotiated by Aspect US and other affiliates, thus companies functionally dissimilar with that of assessee need to be deselected. Information Technology Enables service segment - Exclusion of company functionally dissimilar and who fails the TPO s own filter of export turnover in excess of 75% of total sales. Determining a negative working capital adjustment in both the SWD services Segment and ITeS segment - HELD THAT - The Assessee is running the business without any working capital risk as compared to the comparables. Therefore, requirement for adjustment of negative working capital does not arise. negative working capital adjustment shall not be made in case of a captive service provider as there is no risk and it is compensated on a total cost plus basis - Ground of Assessee is allowed. Re-computation of deduction under Section 10A by reducing travel expenses incurred in foreign currency and communication charges only from export turnover - HELD THAT - Although the DRP rejected the primary contention of the Assessee that neither the telecommunication charges nor the travel expenses ought to be reduced from its export turnover, it accepted its alternate contention that they should also be reduced from its total turnover by following the decision of Tata Elxsi Ltd. 2011 (8) TMI 782 - KARNATAKA HIGH COURT upheld by the Hon ble Supreme Court in the case of CIT v. HCL Technologies Ltd. 2018 (5) TMI 357 - SUPREME COURT . Accordingly, it directed the AO to exclude the above expenses from both its export and total turnovers while computing the deduction allowable under Section 10A. Thus, on the basis of the DRP s above directions, the disallowance under Section 10A came to be deleted in toto in the final assessment order. - Decided against revenue.

Issues Involved:
1. Determination of Arm's Length Price (ALP) for Software Development Services (SWD) and Information Technology Enabled Services (ITeS).
2. Exclusion and inclusion of certain comparable companies.
3. Application of specific filters for comparables.
4. Treatment of foreign exchange gains.
5. Negative working capital adjustment.
6. Computation of deduction under Section 10A of the Income Tax Act.

Detailed Analysis:

1. Determination of Arm's Length Price (ALP) for SWD and ITeS:
The primary issue in both appeals is the determination of ALP for international transactions involving the provision of SWD and ITeS by the assessee to its Associated Enterprises (AEs). The Transaction Net Margin Method (TNMM) was accepted as the Most Appropriate Method (MAM) for determining the ALP, with Operating Profit/Total Cost (OP/TC) as the profit level indicator.

2. Exclusion and Inclusion of Comparable Companies:
- Revenue's Appeal:
- Acropetal Technologies Ltd.: Excluded due to failure in employee cost filter and service revenue filter.
- Mindtree Ltd. and RS Software (India) Ltd.: Initially excluded by the DRP for onsite development activities but included by the Tribunal as the filter was not applied by the TPO.
- E-Infochips Ltd.: Excluded due to lack of segmental information and presence of significant inventory.
- ICRA Techno Analytics Ltd.: Excluded due to lack of segmental information.
- Infosys Technologies Ltd.: Excluded for being functionally dissimilar due to its engagement in software products and high brand value.
- Evoke Technologies Ltd.: Included as it was comparable and consistently held as such by the Tribunal.
- Cosmic Global Ltd.: Initially excluded by the DRP but included by the Tribunal as the assessee did not object to its inclusion.

- Assessee's Appeal:
- Sasken Communication Technologies Ltd.: Excluded due to engagement in the development of software products and high R&D expenditure.
- CG Vak Software and Export Ltd.: Included as it was functionally comparable and passed the employee cost filter.
- Larsen & Toubro Infotech Ltd. and Persistent Systems Ltd.: Remanded to the TPO for reconsideration based on judicial decisions.
- Tata Elxsi Ltd.: Remanded to the TPO for reconsideration based on judicial decisions.

3. Application of Specific Filters for Comparables:
The DRP applied certain filters such as onsite revenue filter and employee cost filter, which were not applied by the TPO. The Tribunal upheld some exclusions based on these filters while rejecting others where the application of filters was arbitrary.

4. Treatment of Foreign Exchange Gains:
The DRP directed that foreign exchange gains be treated as operating in nature while computing the margins of the assessee and the comparable companies. The Tribunal upheld this direction.

5. Negative Working Capital Adjustment:
The Tribunal held that negative working capital adjustment should not be made in the case of a captive service provider as there is no risk and it is compensated on a total cost-plus basis.

6. Computation of Deduction under Section 10A:
The DRP directed the AO to exclude telecommunication expenses and travel expenses incurred in foreign currency from both the export turnover and the total turnover while computing the deduction under Section 10A, following the decision of the Karnataka High Court in CIT v. Tata Elxsi Ltd. This direction was upheld by the Tribunal.

Conclusion:
The Tribunal allowed the appeals of both the assessee and the revenue in part. The TPO was directed to recompute the ALP for both SWD and ITeS segments as per the Tribunal's directions, and the computation of deduction under Section 10A was to be done in accordance with the jurisdictional High Court's decision.

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