2016 (3) TMI 1210 - AT - Income Tax

Appeal Allowed with Directions on ALP Adjustment and Expenditure Treatment

The appeal was partly allowed with directions to exclude certain comparables, adjust the Arm's Length Price (ALP), consider the tolerance range benefit, ... Arm's Length Price - functional comparability - transfer pricing under TNMM - exclusion of non-comparable companies from comparable set - tolerance range under proviso to Section 92C(2) - exclusion of foreign currency expenses from total turnover for computation of relief under section 10A - treatment of application software expenditure as revenue expenditure - consequential interest under sections 234B and 234DArm's Length Price - functional comparability - exclusion of non-comparable companies from comparable set - transfer pricing under TNMM - Validity of the comparable set selected by the TPO and DRP and exclusion of specified companies from the comparable set for determination of ALP - HELD THAT: - The Tribunal examined the functional profile of comparables selected by the TPO/Assessing Officer and, applying consistent precedent of co ordinate benches for the same assessment year, directed exclusion of several companies from the comparable set for the software development services segment. Following earlier Tribunal decisions, M/s Accel Transmatics Ltd. (Seg.) and M/s KALS Infosystems Ltd. are excluded as functionally dissimilar to a pure software development service provider. Flextronics Software Systems Ltd. (Seg.) and Megasoft Ltd. are excluded on the grounds indicated by co ordinate bench decisions (including effects of amalgamation, product orientation and non contemporaneous accounting year). Persistent Systems Ltd. and Infosys Technologies Ltd. are also directed to be excluded for being functionally non comparable (product orientation, scale, risk profile and other differentiating features). Tata Elxsi Ltd. (Seg.)-though originally included by the assessee-was admitted as an additional ground and, on functional analysis and precedent, is directed to be excluded. The Tribunal directed the AO/TPO to rework the ALP after excluding these non comparable entities.Directed exclusion of specified companies from the comparable set and remand to AO/TPO to recompute ALP after excluding themTolerance range under proviso to Section 92C(2) - Arm's Length Price - Applicability of the +/-5% tolerance range while computing ALP after reconstitution of the comparable set - HELD THAT: - The Tribunal held that, after the directed exclusions of certain comparables, the Assessing Officer/ TPO must apply the benefit of the proviso to Section 92C(2) (i.e., the tolerance range of +/- 5%) in computing the arm's length margin where applicable. This direction requires the AO/TPO to consider the statutory tolerance while finalising comparability adjustments and the ALP.Directed AO/TPO to consider the proviso to Section 92C(2) (tolerance range +/-5%) when recomputing ALPExclusion of foreign currency expenses from total turnover for computation of relief under section 10A - Section 10A relief - Whether expenses incurred in foreign currency excluded from export turnover should also be excluded from total turnover for computation of relief under section 10A - HELD THAT: - Relying on the jurisdictional High Court's decision in CIT v. M/s Tata Elxsi Ltd. & Others, the Tribunal held that when certain expenses (such as freight, telecommunication, insurance or other expenses in foreign currency) are excluded from export turnover, the same components must also be excluded from total turnover in the denominator for computing section 10A relief. The Tribunal emphasised uniformity between numerator and denominator of the formula used for apportionment and directed the AO to exclude such foreign currency expenses from total turnover as well.Directed Assessing Officer to exclude the expenses incurred in foreign currency from total turnover as well when computing relief under section 10ATreatment of application software expenditure as revenue expenditure - capital versus revenue treatment of software expenditure - Whether expenditure on purchase of application software (right to use) is revenue or capital in nature - HELD THAT: - Following co ordinate bench decisions and applicable High Court precedents, the Tribunal held that expenditure on application software-where it is for right to use/licence for business operations and does not create a separate capital asset of enduring character-should be treated as revenue expenditure. The Tribunal noted that the expenditure in the assessee's case was for application software and, on the facts and precedent, allowed the claim as revenue in nature.Held expenditure on application software to be revenue expenditure and allowed the claimConsequential interest under sections 234B and 234D - Levy of interest under sections 234B and 234D consequential to the additions - HELD THAT: - The Tribunal observed that interest under Sections 234B and 234D is consequential in nature to the adjustments made and recorded the position accordingly.Recorded that interest under Sections 234B and 234D is consequential (mandated by outcome) and accordingly treated as consequentialFinal Conclusion: The appeal is partly allowed: the Tribunal directed exclusion of specified non comparable companies from the TPO/DRP comparable set and remand to the AO/TPO to recompute the ALP applying the +/-5% tolerance where applicable; directed exclusion of foreign currency expenses from total turnover for section 10A computations; held application software expenditure to be revenue in nature and allowed; and treated interest under sections 234B and 234D as consequential. Issues Involved:1. Transfer Pricing2. Adjustments under Section 10A of the Act3. Others (Disallowance of computer software expenses)4. Consequential Ground (Levy of interest under Section 234B and Section 234D)Detailed Analysis:Transfer Pricing:1. General Grounds: Ground No. 1 was deemed general and did not require specific adjudication. Ground Nos. 2, 5, 6, and 8 were dismissed as not pressed by the assessee.2. Objections to Comparables: Ground Nos. 3 and 4 addressed the objections against the comparables selected by the TPO for determining the Arm's Length Price (ALP). The assessee, part of the Hewlett Packard Group, provided R&D services and reported an operating profit margin of 8.37%. The TPO rejected 33 out of 39 comparables selected by the assessee, citing reasons such as mergers, revenue thresholds, and functional dissimilarity. The TPO included 14 new comparables, resulting in an adjusted arithmetic mean margin of 18.49%, leading to an upward adjustment of Rs. 54,25,32,620 under Section 92CA of the Act.3. Functional Comparability: The Tribunal examined the functional comparability of the selected companies:- Accel Transmatics Ltd. (Seg.) and KALS Technology Ltd.: These companies were excluded based on prior Tribunal decisions, as they were found to be functionally different from the assessee.- Flextronics Software Ltd. (Seg.): Excluded due to extraordinary events of amalgamation and lack of segmental results, as upheld by the Hyderabad Tribunal and the Hon'ble High Court of Andhra Pradesh & Telangana.- Megasoft: Excluded due to its product development focus and different financial year, following the Tribunal's decision in Goldman Sachs Services Pvt. Ltd.- Persistent System Ltd.: Excluded due to functional differences and acquisition events, as upheld by the Hyderabad Tribunal and the Hon'ble High Court of Andhra Pradesh & Telangana.- Infosys Technologies Ltd.: Excluded based on functional dissimilarity and significant differences in business scale and risk profile, as confirmed by the Hon'ble Delhi High Court in Agnity India Technologies Pvt. Ltd.- Tata Elxsi Ltd. (Seg.): Excluded based on functional dissimilarity, following the Tribunal's decision in Goldman Sachs Services Pvt. Ltd.4. Tolerance Range: Ground No. 7 addressed the benefit of the tolerance range of +/- 5% as per the proviso to Section 92C(2) of the Act. The Tribunal directed the AO/TPO to consider this benefit while computing the ALP after excluding certain comparables.Adjustments under Section 10A of the Act:1. Exclusion of Expenditure: Ground Nos. 9 and 10 involved the exclusion of expenditure incurred in foreign currency from export turnover. The Tribunal followed the Hon'ble jurisdictional High Court's judgment in CIT v M/s Tata Elxsi Ltd. & Others, which mandated that such expenses should also be excluded from total turnover.Others (Disallowance of Computer Software Expenses):1. Nature of Expenditure: Ground No. 11 addressed the disallowance of computer software expenses treated as capital in nature. The Tribunal, following the decision in Broadcom Communications Technologies Pvt. Ltd. Vs. DCIT, held that expenditure on application software should be treated as revenue expenditure.Consequential Ground:1. Levy of Interest: Ground No. 12 regarding the levy of interest under Sections 234B and 234D was deemed consequential and mandatory.Conclusion:The appeal was partly allowed, with specific directions to exclude certain comparables and adjust the ALP accordingly, consider the benefit of the tolerance range, exclude foreign currency expenditure from total turnover, and treat application software expenses as revenue expenditure.