Transfer Pricing Tribunal Decision: Excluding Comparables, PLI Recomputation, & Adjustments

The tribunal upheld the CIT(A)'s order regarding the exclusion of certain comparables based on functional dissimilarity and related party transaction percentages. The tribunal directed the AO/TPO to re-compute the average Profit Level Indicator (PLI) of comparable companies and make Transfer Pricing adjustments if the difference is beyond +/- 5% of the assessee's profit. The appeals of both the assessee and the revenue were partly allowed for statistical purposes, with the cross-objection of the assessee being allowed.

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Issues Involved:
1. Validity of the CIT(A) order.
2. Functional comparability of the appellant with entrepreneurial software development service providers.
3. Risk differential adjustment for limited risk engineering design services.
4. Consideration of revised set of comparables submitted by the appellant.
5. Opportunity of being heard before determining transfer pricing adjustment.
6. Application of multiple year/prior year data for comparable companies.
7. Use of selective information by the TPO.
8. Use of data available at the time of assessment proceedings.
9. Economic analysis by the CIT(A) during appeal proceedings.
10. Levy of interest under section 234B of the Act.
11. Levy of interest under section 234D of the Act.
12. Initiation of penalty proceedings under section 271(1)(C) of the Act.
13. Exclusion of expenses incurred in foreign currency from total turnover.
14. Exclusion of companies with related party transactions.
15. Exclusion of companies due to functional dissimilarity.
16. Eligibility for standard deduction under section 92C(2) of the Act.

Detailed Analysis:

1. Validity of the CIT(A) Order:
The assessee challenged the CIT(A)'s order as bad in law and liable to be quashed. The CIT(A) was criticized for ignoring the functional profile of the appellant and failing to establish comparability with entrepreneurial software development service providers.

2. Functional Comparability:
The CIT(A) was found to have erred in ignoring the limited risk nature of the engineering design services provided by the appellant and not providing an appropriate adjustment towards the risk differential.

3. Risk Differential Adjustment:
The CIT(A) did not consider the revised set of comparables submitted by the appellant, which were more closely comparable to the functional profile of the appellant.

4. Revised Set of Comparables:
The CIT(A) failed to provide an opportunity of being heard before arriving at a conclusion on the functional profile of the appellant and consequently while determining the transfer pricing adjustment.

5. Opportunity of Being Heard:
The CIT(A) did not apply multiple year/prior year data for comparable companies while determining the arm's length price.

6. Multiple Year/Prior Year Data:
The CIT(A) upheld the approach adopted by the TPO of collecting selective information of the companies by exercising power granted under section 133(6) of the Income Tax Act, 1961, which was not available to the appellant in the public domain.

7. Use of Selective Information:
The CIT(A) upheld the TPO's approach of using data as at the time of assessment proceedings, instead of that available as on the date of preparing the TP documentation for comparable companies while determining the arm's length price.

8. Use of Data at Time of Assessment:
The CIT(A) performed his own economic analysis during the appeal proceedings by modifying the filters applied by the TPO without providing any opportunity of being heard to the appellant.

9. Economic Analysis by CIT(A):
The CIT(A) upheld the order of the Deputy Commissioner of Income Tax in consequently levying interest under section 234B of the Act.

10. Levy of Interest under Section 234B:
The CIT(A) upheld the order of the Deputy Commissioner of Income Tax in consequently levying interest under section 234D of the Act.

11. Levy of Interest under Section 234D:
The learned Assessing Officer erred in initiating penalty proceedings under section 271(1)(C) of the Act.

12. Penalty Proceedings under Section 271(1)(C):
The CIT(A) erred in directing the Assessing Officer to exclude expenses incurred in foreign currency towards travel, freight, telecommunication, and insurance charges from total turnover, whereas such exclusion is permitted to arrive at the export turnover only as per the definitions given in Sec. 10A of the Act.

13. Exclusion of Expenses Incurred in Foreign Currency:
The CIT(A) erred in holding that the TPO ought to have excluded comparables having any related party transactions, not only those with more than 25% related party transactions on sales.

14. Exclusion of Companies with Related Party Transactions:
The CIT(A) erred in holding that M/s Flextronics Software Systems Ltd., and M/s Celestial Labs cannot be taken as comparables being functionally different.

15. Exclusion of Companies Due to Functional Dissimilarity:
The CIT(A) erred in holding that the assessee is eligible for a standard deduction of 5% from the Arm's Length Price (ALP) under the proviso to section 92C(2) of the Income Tax Act.

16. Standard Deduction under Section 92C(2):
The CIT(A)'s order was opposed to law and facts of the case.

Judgment Analysis:

Corporate Tax Issue - Deduction under Section 10A:
The AO excluded expenses incurred in foreign currency towards travel, freight, telecommunication, and insurance charges from the export turnover but not from the total turnover. The Hon’ble Karnataka High Court in the case of M/s Tata Elxsi Ltd. held that total turnover is the sum total of export turnover and domestic turnover. Therefore, if an amount is excluded from export turnover, the total turnover goes down by the same amount. Respectfully following this judgment, the tribunal declined to interfere with the order of the CIT(A) on this issue, rejecting grounds 2 and 3 of the revenue’s appeal and allowing the grounds raised in the cross-objection by the assessee.

Transfer Pricing Issue - Exclusion of Comparables:
The tribunal addressed the exclusion of various comparables requested by the assessee. The tribunal directed the AO/TPO to exclude companies such as M/s Avani Cimcon Tech. Ltd., M/s Celestial Labs Ltd., M/s Flextronics Software Systems Ltd., M/s Geometric Ltd., M/s Infosys Ltd., M/s Ishir Infotech Ltd., M/s Kals Information Systems Ltd., M/s Lucid Software Ltd., M/s Tata Elxsi Ltd., and M/s Wipro Ltd., from the list of final comparables based on functional dissimilarity, higher RPT percentage, and other factors. For M/s Megasoft Ltd., the tribunal directed the AO/TPO to consider the profit margin of the software services segment only, noted at 23.11%.

Re-computation of Average PLI:
The tribunal directed the AO/TPO to re-compute the average PLI of comparable companies as per the above directions. If the same is within +/- 5% of the profit of the assessee company, no TP adjustment is to be made.

Conclusion:
The appeals of the assessee and the revenue were partly allowed for statistical purposes, whereas the cross-objection of the assessee was allowed. The order was pronounced in the open court.

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