2022 (5) TMI 350 - AT - Income Tax

TP Adjustment - comparable selection - Functional similarity - HELD THAT - Avani Cincome Technologies Ltd. - We find that this was not allowed as a comparable for the similarly placed companies owing to high operating margins and different asset base with regard to Motorola Solutions India Pvt. Ltd. During the year with regard to the assessee, we find that the comparable has replied that they are into software development only. We find that 97 per cent. of the revenue of the comparable is from software development which is similar to the functions of the assessee who is also having a software development facility centre. Hence, the contention of the learned authorised representative that in the absence of segmental data, the Avani CT Ltd. is not a right comparable, cannot be accepted. Celestial Labs Ltd. comparable is dissimilar to the functions performed by the assessee-company. E-Zest Solutions Ltd. - There is no segmental data available in the annual report of the company. The service income filter which was applied by the Transfer Pricing Officer clearly has not been followed by the Transfer Pricing Officer in this company while selecting as comparable. Therefore, this company has to be excluded. We, therefore, direct Transfer Pricing Officer to exclude this company from comparable. Flextronics Software Systems Ltd.is not a correct comparable owing to the diversified segment of software services and products are grouped together. Helios and Motherson (IT) Ltd. comparable fails the employee cost filter implied by the Transfer Pricing Officer himself and also the fact that the company is engaged in the services like information technology enables services/ business process outsourcing/off-shore delivery/project management and maritime practices makes it functionally dissimilar to be a right comparable. KALS Information Systems Ltd. - The reply of the company that the use of ready-made object laboratories is only to the tune of about (0.33 to 3) per cent. in the year 2005-06 and 2006-07 has been examined by the Tribunal and came to the conclusion that what has been written is that the company's use the ready-made object laboratories is only to the tune of maximum three per cent. and it doesn't convey that the software products' revenue stands at three per cent. . On examination of the reply in detail, the Tribunal rejected the comparable hitherto. Hence, we direct that this comparable needs to be excluded. Persistent Systems Ltd.directed to be deleted owing to amalgamation of the company.- See Infogains India Pvt. Ltd. 2020 (3) TMI 1138 - ITAT DELHI Since, the facts remain undisputed, owing to the incidence of the extraordinary event, the same cannot be considered as a right comparable. Infosys Technologies Ltd company has set up a network of research labs and granted patents which are intangible assets on which revenue is generated. Infosys is a giant risk taking company. Besides that, it is engaged in development and sale of software products and also owns intangible assets. The assessee company is engaged in the business of digital switching equipment and related software, cellular exchange/transmission equipment and provides related services, intelligent network and broadband solutions, equipment and related services. Thus, the functions of both the companies are different. There is no segmental bifurcation available of Infosys Limited. Hence, the comparable may be scored through the list of comparable. Similar observation is applicable to Wipro Ltd. Thirdware Solutions Ltd. is engaged in product development and earns revenue from trading of software licences and subscription. Further, the segmental information of different streams of revenue is not available. Megasoft Ltd. - Transfer Pricing Officer while determining the arm's length price used the entity wise margins instead of segmental margins. Hence, needs to be obliterated. Akshay Software Technologies Ltd. and SQL Star International Ltd., cannot be considered as the revenue filter and the export turnover filter have not been met. Ishir Infotech Ltd. the information provided under section 133(6) clears the employee filter. Lucid Software Ltd. - The company submitted that it is a pure software development company and does not have any revenue from sale of products or licence. Hence, the appellant's contention on the similarity of the functions is overruled. Similarly, the contention that amount incurred in product development and owing of the software product does not influence the profit levels on annual basis. Hence, we decline to interfere with this comparable. Capitalization of Software Expenses - assessee debited software expenses to its profit and loss account whereas the Assessing Officer altered the expenses to capital expenditure - HELD THAT - We have also gone the judgment of the hon'ble apex court in the case of Empire Jute Co. Ltd. v. CIT 1980 (5) TMI 1 - SUPREME COURT From the facts, relevant to the instant case, we find that the assessee has not acquired any capital asset of enduring in nature with regard to the software purchases. It is the user rights which has been purchased by the assessee and requires updation and modification at regular intervals. Hence, it cannot be said that the assessee has acquired any asset capital in nature by way of payment of software expenses. Hence, the addition made by the Assessing Officer is directed to be deleted. Computation of deduction under section 10A - exclusion of communication charges, expenditure incurred in foreign exchange from the export turnover - HELD THAT - The issue of computation of deduction under section 10A has reached a finality in view of the judgment of the hon'ble Supreme Court in the case of CIT v. HCL Technologies Ltd. 2018 (5) TMI 357 - SUPREME COURT as held that when the object of the formula is to arrive at the profit from export business, expenses excluded from export turnover have to be excluded from total turnover also. Otherwise, any other interpretation makes the formula unworkable and absurd. Hence, we are satisfied that such deduction shall be allowed from the total turnover in same proportion as well.

Summary

Issues Involved:
1. Transfer Pricing Adjustments
2. Capitalization of Software Expenses
3. Exclusion of Communication Charges from Export Turnover in Computing Deduction under Section 10A
4. Exclusion of Expenditure Incurred in Foreign Currency from Export Turnover in Computing Deduction under Section 10A
5. Exclusion from Total Turnover
6. Initiation of Penalty under Section 271(1)(c)

Detailed Analysis:

1. Transfer Pricing Adjustments:
The assessee contested the adjustments made by the Assessing Officer (AO) and Transfer Pricing Officer (TPO) to the income, arguing that the international transactions did not violate the arm's length principle. Key points of contention included:
- The Dispute Resolution Panel (DRP) erred in confirming the adjustments.
- The assessee claimed entitlement to a tax holiday under Section 10A, negating any motive for manipulating transfer prices.
- The TPO disregarded the arm's length price determined by the assessee and used selective information not available in the public domain.
- The TPO's methodology included exclusion of companies with different financial years, export sales less than 25%, and diminishing revenues, among others, which the assessee argued was inconsistent and unjustified.
- High-profit companies were included for benchmarking, which was inappropriate for a low-risk captive unit like the assessee.
- The TPO's approach to comparability analysis and the rejection of certain companies as comparables were inconsistent and based on erroneous grounds.

The Tribunal examined the comparables used by the TPO and found several to be inappropriate due to functional dissimilarities, lack of segmental data, and other inconsistencies. Specific companies like Avani Cincome Technologies Ltd., Celestial Labs Ltd., E-Zest Solutions Ltd., and others were excluded from the comparables list based on detailed functional analysis and previous judicial pronouncements.

2. Capitalization of Software Expenses:
The AO had capitalized software expenses, treating them as capital expenditure. The assessee argued that these were revenue expenses as the software acquired was primarily application software with no enduring benefit. The Tribunal referred to various judicial precedents and concluded that the software expenses did not result in the acquisition of a capital asset of enduring nature. Hence, the addition made by the AO was directed to be deleted.

3. Exclusion of Communication Charges from Export Turnover in Computing Deduction under Section 10A:
The AO excluded communication charges from the export turnover, which the assessee contested. The Tribunal referred to the Supreme Court judgment in CIT v. HCL Technologies Ltd., which clarified that expenses excluded from export turnover must also be excluded from total turnover to avoid an illogical result. Following this principle, the Tribunal allowed the appeal of the assessee on this ground.

4. Exclusion of Expenditure Incurred in Foreign Currency from Export Turnover in Computing Deduction under Section 10A:
Similar to the communication charges issue, the AO excluded expenses incurred in foreign currency from the export turnover. The Tribunal, again referring to the Supreme Court judgment in CIT v. HCL Technologies Ltd., held that such expenses should also be excluded from total turnover to maintain consistency in the formula for computing deduction under Section 10A.

5. Exclusion from Total Turnover:
The Tribunal reiterated the principle that any expenses excluded from export turnover must also be excluded from total turnover to ensure a fair and logical computation of deductions under Section 10A.

6. Initiation of Penalty under Section 271(1)(c):
The AO initiated penalty proceedings under Section 271(1)(c). However, given the Tribunal's findings in favor of the assessee on the primary issues, the initiation of penalty was rendered moot.

Conclusion:
The Tribunal allowed the appeals of the assessee, directing the deletion of the adjustments made by the AO and TPO, and ensuring a consistent approach in computing deductions under Section 10A by excluding certain expenses from both export turnover and total turnover. The order emphasized the importance of functional comparability and adherence to judicial precedents in transfer pricing matters.