2021 (1) TMI 775 - AT - Income Tax

TP Adjustment - Comparable selection - HELD THAT - Assessee is a company engaged in the business of software development. It rendered software development services to its Associated Enterprise (AE) thus companies functionally dissimilar with that of assessee need to be deselected. CIT(A) directed computation of margins of company on a segmental basis - The plea of revenue is that the profit margin at the entity level should be taken which in our view cannot be accepted. In the TNMM what is to be compared is only the transaction and margin from the transaction. The transaction for which the ALP is sought to be determined is rendering of software development services and therefore the plea of revenue to take the enterprise level profit margin is devoid of any merit. Whether working capital adjustment should be given or not? - We find that the reasons given by the CIT(A) for not allowing working capital adjustment are not the same reasons as was given in the case of Huawei Technologies India Pvt. Ltd. v. JCIT 2018 (10) TMI 1796 - ITAT BANGALORE wherein Tribunal held that working capital adjustment has to be given. Deduction u/s 10A - Computation of deduction - 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 communication charges should be excluded 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.

Summary

Issues Involved:
1. Exclusion of certain comparable companies for determining the arm's length price (ALP).
2. Working capital adjustment.
3. Exclusion of communication charges from export turnover and total turnover.

Issue-wise Detailed Analysis:

1. Exclusion of Certain Comparable Companies for Determining the ALP:

The assessee, engaged in software development services, contested the inclusion of specific comparable companies by the Transfer Pricing Officer (TPO). The TPO had identified 26 comparable companies, but the assessee sought the exclusion of 13 of these companies. The Tribunal referenced a similar case, Sonus Networks India Pvt. Ltd. v. DCIT, where 10 out of the 13 companies were excluded based on the following findings:

- Avani Cimcon Technologies Ltd.: Excluded due to revenue from software products without segmental details.
- Celestial Labs Ltd.: Excluded as it is primarily a research & development company.
- E-Zest Solutions Ltd.: Excluded due to its engagement in product development and high-end technical services, categorized as KPO services.
- Helios & Matheson Information Technology Ltd.: Excluded due to engagement in the sale of software products.
- Infosys Technologies Ltd.: Excluded due to significant intangibles and revenue from software products without segmental details.
- KALS Information Systems Ltd.: Excluded due to revenue from both software development and products, and involvement in training.
- Persistent Systems Ltd.: Excluded due to engagement in product development and design services without segmental details.
- Wipro Ltd.: Excluded due to engagement in both software and product development services without segmental bifurcation.
- Flextronics Software Systems Ltd. (Seg): Excluded due to contradictory information obtained under section 133(6) and annual report.
- Ishir Infotech Ltd.: Excluded as it did not meet the 25% employee cost filter.

The Tribunal directed the exclusion of these companies and remanded the comparability of R Systems International Ltd. to the TPO for further examination.

2. Working Capital Adjustment:

The Tribunal addressed the issue of whether working capital adjustment should be allowed. The CIT(A) had denied the adjustment, but the Tribunal referenced the case of Huawei Technologies India Pvt. Ltd. v. JCIT, where it was held that working capital adjustment must be given. The Tribunal emphasized that the net profit margin from comparable uncontrolled transactions should be adjusted for differences that could materially affect the profit margin. The Tribunal found no error in the TPO's working capital adjustment and directed that the adjustment as worked out by the TPO should be allowed.

3. Exclusion of Communication Charges from Export Turnover and Total Turnover:

The Tribunal considered the revenue's appeal regarding the exclusion of communication charges from export turnover and total turnover. The Tribunal followed the decision of the Karnataka High Court in CIT v. Tata Elxsi Ltd., which held that communication charges should be excluded from both export turnover and total turnover. This decision was upheld by the Supreme Court in CIT v. HCL Technologies Ltd. Consequently, the Tribunal rejected the revenue's grounds on this issue.

Conclusion:

In summary, the Tribunal allowed the exclusion of certain comparable companies as requested by the assessee, directed the TPO to compute the ALP accordingly, allowed the working capital adjustment, and upheld the exclusion of communication charges from both export turnover and total turnover. The appeal by the revenue was dismissed, while the appeal by the assessee was partly allowed.