2016 (3) TMI 1126 - AT - Income Tax

Tribunal Grants Relief: Excludes Comparables, Validates Rent Equalization, and Confirms Apportionment Method

The Tribunal partly allowed the appeal of the assessee, directing the exclusion of certain comparables, allowing the claim regarding rent equalization, ... Transfer Pricing - comparability and selection of comparables - Most Appropriate Method - TNMM - Use of information obtained under section 133(6) and obligation to furnish to assessee - Arithmetical mean and working capital adjustment in benchmarking - Tolerance range under the proviso to Section 92C(2) - Section 10A - parity between numerator and denominator while excluding export related expenses - Set off of unabsorbed depreciation under Section 10A - Apportionment of common/head office expenses - consistency and head count basis - Allowability of provision for rent equalisation - Assessment of interest disallowance - tracing of borrowed funds / temporal linkage - DRP directions to afford opportunity to assessee and remand to Assessing OfficerTransfer Pricing - comparability and selection of comparables - Arithmetical mean and working capital adjustment in benchmarking - Tolerance range under the proviso to Section 92C(2) - Use of information obtained under section 133(6) and obligation to furnish to assessee - Exclusion of specified comparable companies and recalculation of ALP for software development services - HELD THAT: - Tribunal examined the set of 20 comparables used by the TPO for benchmarking the assessee's software development services. Following analysis of functional comparability, prior coordinate bench decisions and defects in the TPO's selection process (including reliance on non public Section 133(6) material without furnishing it to the assessee and lack of contemporaneous FAR analysis), the Tribunal held that 12 specific companies are not functionally comparable and directed the AO/TPO to exclude them. The Tribunal directed recomputation of the arm's length price after excluding those companies and after allowing claimed risk and working capital adjustments and applying the tolerance range of +/-5% under the proviso to Section 92C(2). The Tribunal also admitted and upheld the assessee's additional grounds to exclude comparables which the assessee itself had earlier included, where functional dissimilarity (products/IPRs/R&D/acquisitions/related party intensity) was established.TPO/AO directed to omit the 12 named companies from the comparable set and recompute ALP with risk and working capital adjustments and applying the +/-5% tolerance.Section 10A - parity between numerator and denominator while excluding export related expenses - Allowability of provision for rent equalisation - Computation of deduction under Section 10A: treatment of export related expenses and rent equalisation provision - HELD THAT: - Relying on the jurisdictional High Court precedent, the Tribunal held that where export turnover in the numerator is computed after excluding specified expenses (e.g. travel, telecommunication, insurance attributable to export delivery), the same exclusions must be made from total turnover in the denominator so that numerator and denominator components are uniform. Consequently, the AO was directed to exclude such foreign currency travel expenses from total turnover. On rent equalisation (a provision treated by AO as unascertained liability), the Tribunal held that the DRP erred in ignoring binding High Court authority favourable to the assessee; absent any contrary Supreme Court ruling, the Tribunal allowed the assessee's claim in respect of the rent equalisation amount.A.O. directed to exclude export related expenses from total turnover for Section 10A computation; rent equalisation provision allowed.Assessment of interest disallowance - tracing of borrowed funds / temporal linkage - Disallowance of interest on funds from issue of convertible debentures for acquisition of fixed assets - HELD THAT: - The Assessing Officer disallowed a proportionate interest treating debenture proceeds as applied to fixed asset acquisition. The assessee contended that debenture proceeds were for working capital and that only fixed assets acquired after issue of debentures (or paid for after issue) could be attributed to those funds. The Tribunal found merit in the latter temporal tracing contention and directed the AO to verify exact dates of fixed asset acquisition/payments and, based on those dates, decide disallowance only in respect of fixed assets acquired or paid for after issuance of debentures.AO to verify dates of acquisition/payments and recompute any interest disallowance only for assets acquired/paid for after debenture issuance.DRP directions to afford opportunity to assessee and remand to Assessing Officer - Disallowance of consultancy charges paid to AE (Telelogic Germany) and procedure to be followed - HELD THAT: - The DRP directed the AO to afford a final opportunity to the assessee to substantiate consultancy payments and to decide the disallowance afresh. The Tribunal declined to interfere with the DRP's direction and remitted the matter to the AO, directing that the AO comply with the DRP's instruction and reconsider the disallowance after giving the assessee a hearing and adequate opportunity to produce evidence.Matter remitted to AO to afford final opportunity and to decide on allowability of consultancy charges after hearing the assessee.Apportionment of common/head office expenses - consistency and head count basis - Validity of apportioning common expenses on head count basis - HELD THAT: - The assessee consistently apportioned common/head office expenses between STPI and non STPI units on a head count basis in prior years. The AO switched to a turnover basis without demonstrating that the head count method caused distortion. Applying the consistency principle, the Tribunal held that absent a finding that the prior method distorts profits, the AO was not justified in changing the basis. The Tribunal therefore accepted the head count apportionment and deleted the addition.Assessee's head count basis for apportioning common expenses upheld; AO's addition deleted.Set off of unabsorbed depreciation under Section 10A - Whether deduction under Section 10A is to be allowed without setting off unabsorbed depreciation of other units - HELD THAT: - Following the jurisdictional High Court decisions and subsequent Tribunal precedents, and having regard to the post 2001 amendments and CBDT guidance discussed by the Tribunal, the Tribunal held that the assessee is entitled to deduction under Section 10A without setting off unabsorbed depreciation of other/non 10A units. The Tribunal directed the AO to allow deduction under Section 10A accordingly.AO directed to allow deduction under Section 10A without setting off unabsorbed depreciation of other units.DRP directions to afford opportunity to assessee and remand to Assessing Officer - Consultation of DRP direction regarding reassessment of certain issues (procedural compliance) - HELD THAT: - Where the DRP had directed the AO to reconsider issues (for example, consultancy charge allowability) after affording opportunity, the Tribunal enforced compliance: it refused to interfere with the DRP's procedural direction and mandated that the AO follow the DRP's order and decide after hearing the assessee.AO directed to implement DRP directions and decide the issues after giving the assessee opportunity of hearing.Final Conclusion: The appeal is partly allowed. The Tribunal directed exclusion of twelve named comparables and recomputation of ALP (with risk and working capital adjustments and application of the +/-5% tolerance); directed AO to exclude specified export related expenses from total turnover for Section 10A and allowed rent equalisation provision; upheld the head count method of apportionment; directed AO to allow Section 10A deduction without setting off unabsorbed depreciation of other units; remitted the interest disallowance issue for verification of acquisition/payment dates and remitted the consultancy charges issue to the AO for fresh adjudication after affording the assessee an opportunity to be heard. Penalty proceedings noted as premature and interest under section 234B treated as consequential. Issues Involved:1. Legality of assessment and reference to Transfer Pricing Officer (TPO).2. Comparability analysis for determining arm's length price.3. Erroneous data used by AO/TPO.4. Non-allowance of appropriate adjustments.5. Variation of 5% from the arithmetic mean.6. Computation of deduction under Section 10A.7. Disallowance of interest paid to Telelogic Sweden.8. Disallowance of rent equalization amount.9. Disallowance of consultancy charges paid to Telelogic Germany.10. Ratio adopted for apportioning items of disallowance.11. Set-off of unabsorbed depreciation of earlier years.12. Directions issued by the Dispute Resolution Panel (DRP).13. Levy of interest under Section 234B.14. Initiation of penalty proceedings under Section 271(1)(c).Detailed Analysis:1. Legality of Assessment and Reference to TPO:The assessee challenged the assessment order dated 30.11.2011 and the reference to the TPO, arguing that the AO/TPO failed to establish that the appellant shifted profits outside India. The Tribunal did not provide specific adjudication on this general ground.2. Comparability Analysis for Determining Arm's Length Price:The assessee contested the TPO's comparability analysis, which rejected the filters and search process adopted by the assessee in the Transfer Pricing Study. The TPO included 20 comparable companies, rejecting 12 out of the 17 comparables selected by the assessee. The Tribunal directed the exclusion of 12 companies from the set of comparables based on functional dissimilarity and previous Tribunal decisions, including Avani Cimcon Technologies Ltd., Celestial Biolabs Ltd., E-Zest Solutions Ltd., Infosys Technologies Ltd., KALS Information Systems Ltd., Lucid Software Ltd., Persistent Systems Ltd., Quintegra Solutions Ltd., Softsol India Ltd., Tata Elxsi Ltd., Thirdware Solutions Ltd., and Wipro Ltd. The Tribunal upheld the inclusion of Bodhtree Consulting Ltd. as a comparable.3. Erroneous Data Used by AO/TPO:The Tribunal did not provide specific adjudication on this ground.4. Non-Allowance of Appropriate Adjustments:The Tribunal did not provide specific adjudication on this ground.5. Variation of 5% from the Arithmetic Mean:The Tribunal did not provide specific adjudication on this ground.6. Computation of Deduction under Section 10A:The Tribunal directed the AO to exclude travel expenses incurred in foreign currency from the total turnover as well, following the judgment of the Hon'ble jurisdictional High Court in the case of CIT V Tata Elxsi Ltd & Others.7. Disallowance of Interest Paid to Telelogic Sweden:The Tribunal directed the AO to verify the exact date of acquisition of the fixed assets and decide the issue of disallowance of interest only in respect of the fixed assets acquired post issuance of debentures.8. Disallowance of Rent Equalization Amount:The Tribunal allowed the claim of the assessee regarding the rent equalization amount, following the judgment of the Hon'ble jurisdictional High Court in the case of M/s. Prakash Leasing Limited.9. Disallowance of Consultancy Charges Paid to Telelogic Germany:The Tribunal upheld the DRP's direction to the AO to afford a final opportunity to the assessee to present its case and relevant evidence regarding the consultancy charges.10. Ratio Adopted for Apportioning Items of Disallowance:The Tribunal decided in favor of the assessee, directing the AO to follow the method of apportionment of common expenses on the basis of head count ratio, which had been consistently followed by the assessee in the past.11. Set-off of Unabsorbed Depreciation of Earlier Years:The Tribunal directed the AO to allow deduction under Section 10A without setting off the unabsorbed depreciation, following the judgment of the Hon'ble jurisdictional High Court in the case of CIT vs. Yokogawa India Ltd. & others.12. Directions Issued by the DRP:The Tribunal did not provide specific adjudication on this ground.13. Levy of Interest under Section 234B:The Tribunal noted that the levy of interest under Section 234B is mandatory and consequential in nature.14. Initiation of Penalty Proceedings under Section 271(1)(c):The Tribunal noted that the initiation of penalty proceedings under Section 271(1)(c) is premature at this stage.Conclusion:The Tribunal partly allowed the appeal of the assessee, directing the exclusion of certain comparables, allowing the claim regarding rent equalization, directing verification of acquisition dates for interest disallowance, and upholding the method of apportionment of common expenses on the basis of head count ratio. The Tribunal also directed the AO to allow deduction under Section 10A without setting off the unabsorbed depreciation.