2020 (12) TMI 728 - AT - Income Tax

TP Adjustment - comparable selection - HELD THAT - Assessee in engaged in the business of provision of Information Technology enabled Services (ITeS), to its wholly owned holding company thus companies functionally dissimilar with that of assessee need to be deselected. Wrong computation of working capital adjustment - HELD THAT - It is clear from the perusal of the submissions made by the assessee and the order of the DRP that the argument with regard to adopting weighted average of the interest rate was not considered by DRP. We are, therefore, of the view that it would be just and appropriate to remand the issue to the TPO/AO for fresh consideration with regard to computation of working capital level and the consequent adjustment on account of working capital. Not considering the foreign exchange fluctuation gain earned by the Company as part of operations for the purpose of computing the Assessee's operating mark-up on total cost to arrive at the arm's length price - HELD THAT - Foreign exchange gain has to be taken as part of the operating profits to the extent that it has nexus with the international transaction in respect of which the ALP is being determined. As far as the issue with regard to treatment of foreign exchange gain as part of operating profit is concerned, this issue is no longer res integra and has been settled by the decision in the case of e4e Business Solutions P. Ltd. v. DCIT 2016 (3) TMI 356 - ITAT BANGALORE . It has been held therein that the gains arising from fluctuation of foreign exchange having nexus with international transaction should be treated as operating income and taken into consideration while computing the operating profit of the assessee. Following the aforesaid decision, we direct the computation of PLI by treating the gains arising from fluctuation of foreign exchange having nexus with international transaction as part of operating income. TPO directed to compute the ALP of the international transaction in question in accordance with the directions contained in this order, after affording the assessee opportunity of being heard. Computation of deduction u/s 10AA - exclusion of telecommunication expenses loss both from the export turnover and total turnover for the purpose of computation of deduction u/s. 10AA - HELD THAT - In the case of CIT v. Tata Elxsi Ltd 2011 (8) TMI 782 - KARNATAKA HIGH COURT has held that charges/expenses relating to telecommunication, insurance charges and foreign exchange loss should be excluded both from export turnover and total turnover while computing deduction u/s.10A of the Act i.e., whatever is removed from the numerator should also be excluded from the denominator while working total turnover and export turnover for allowing deduction u/s.10A. The aforesaid decision of the jurisdictional High Court has been upheld in the case of CIT v. HCL Technologies Ltd.. 2018 (5) TMI 357 - SUPREME COURT . The telecommunication charges should be excluded both from the export turnover as well as total turnover while computing deduction u/s.10AA of the Act.

Summary

Issues Involved:
1. Determination of Arm's Length Price (ALP) for international transactions.
2. Comparability of Infosys BPO Ltd. and TCS e-Serve Ltd.
3. Errors in the computation of working capital adjustment.
4. Consideration of foreign exchange fluctuation gain as part of operating profits.
5. Computation of deduction under section 10AA of the Income Tax Act.

Detailed Analysis:

1. Determination of Arm's Length Price (ALP):
The dispute in this appeal revolves around the determination of the ALP for international transactions related to the provision of Information Technology enabled Services (ITeS) by the assessee to its wholly owned holding company. The assessee adopted the Transaction Net Margin Method (TNMM) as the Most Appropriate Method (MAM) and selected Operating Profit/Operating Cost (OP/OC) as the Profit Level Indicator (PLI). The Transfer Pricing Officer (TPO) accepted TNMM and OP/OC but identified different comparable companies, leading to an average arithmetic mean of 28.11% for the comparables' profit margins. Consequently, an addition of ?13,97,42,097 was made to the total income of the assessee.

2. Comparability of Infosys BPO Ltd. and TCS e-Serve Ltd.:
The assessee contested the inclusion of Infosys BPO Ltd. and TCS e-Serve Ltd. as comparables. The Tribunal referred to previous decisions where Infosys BPO Ltd. was excluded due to its high turnover, brand value, and extraordinary events like acquisitions. Similarly, TCS e-Serve Ltd. was excluded because of its high turnover, brand value, and engagement in diversified activities including KPO services. The Tribunal directed the exclusion of these companies from the list of comparables for determining the ALP.

3. Errors in the Computation of Working Capital Adjustment:
The assessee pointed out computational errors in the TPO's order regarding the working capital adjustment. Specifically, the TPO used a simple average interest rate of 13.85% instead of a weighted average rate of 14.40%. The Tribunal noted that the Disputes Resolution Panel (DRP) did not consider the argument for using the weighted average rate. The issue was remanded to the TPO/AO for fresh consideration.

4. Consideration of Foreign Exchange Fluctuation Gain:
The assessee argued that foreign exchange fluctuation gains should be considered as part of operating profits. The Tribunal upheld this view, citing consistent decisions by the Bangalore Benches of ITAT. It was directed that gains arising from foreign exchange fluctuations, having a nexus with the international transaction, should be treated as operating income for computing the operating profit.

5. Computation of Deduction under Section 10AA:
The assessee raised issues regarding the computation of deduction under section 10AA, particularly the exclusion of telecommunication charges from the Export Turnover (ET) without corresponding reduction in Total Turnover (TT). The Tribunal referred to the Karnataka High Court's decision in CIT v. Tata Elxsi Ltd., which mandates that expenses excluded from the numerator (export turnover) should also be excluded from the denominator (total turnover). This principle was upheld by the Supreme Court in CIT v. HCL Technologies Ltd. The Tribunal directed that telecommunication charges should be excluded from both ET and TT while computing the deduction under section 10AA.

Conclusion:
The appeal by the assessee was partly allowed, with specific directions for the exclusion of Infosys BPO Ltd. and TCS e-Serve Ltd. from the list of comparables, recomputation of working capital adjustment, inclusion of foreign exchange gains in operating profits, and proper computation of deduction under section 10AA. The TPO was directed to recompute the ALP and other adjustments in accordance with the Tribunal's directions.