2015 (5) TMI 1138 - AT - Income Tax

Tribunal Adjusts Comparable Companies for Section 10A Deduction

The Tribunal allowed the appeal by the assessee, directing the exclusion of certain comparable companies, allowing the deduction under Section 10A, and ... Determination of Arms Length Price under Section 92CA/92C - Transactional Net Margin Method (TNMM) - Comparability and selection of comparable uncontrolled companies - Turnover filter for comparables (upper limit for small/mid sized taxpayers) - Exclusion of comparables for functional dissimilarity (product/IPP/R&D vs services) - Working capital adjustment in transfer pricing comparables - Deduction under section 10A for STP unitsDetermination of Arms Length Price under Section 92CA/92C - Transactional Net Margin Method (TNMM) - Comparability and selection of comparable uncontrolled companies - Turnover filter for comparables (upper limit for small/mid sized taxpayers) - Exclusion of comparables for functional dissimilarity (product/IPP/R&D vs services) - Working capital adjustment in transfer pricing comparables - Validity of transfer pricing adjustment made by TPO/DRP by taking the arithmetic mean of 26 comparables and the resultant addition to assessee's income - HELD THAT: - The Tribunal held that TNMM was the appropriate method but the set of comparable uncontrolled companies chosen by the TPO required pruning on established comparability principles. Companies that were functionally dissimilar (product developers, R&D/biotech, diversified businesses or having significant related party transactions) were to be excluded. The Tribunal applied the turnover filter endorsed by earlier Benches (upper limit ~ Rs.200 crores for comparability with the assessee of much smaller size) and directed exclusion of several large comparables. After excluding the identified comparables and applying the working capital adjustment, the arithmetic mean of the remaining comparables produced an arms length margin within the permitted +/-5% range of the assessee's actual margin. Because the adjusted mean (13.33%) made the assessee's margin (10.64%) fall within the tolerance prescribed by the second proviso to section 92CA(2), the transfer pricing addition confirmed by the DRP/AO was deleted. [Paras 7, 12, 13]Transfer pricing adjustment confirmed by the DRP/AO is set aside and deleted; specified comparables are excluded and no addition is sustained.Deduction under section 10A for STP units - Allowability of deduction claimed under section 10A in respect of the Bangalore STP unit (taken over from Lara Networks) - HELD THAT: - On identical facts the Tribunal earlier held that the Bangalore unit was not formed by reconstruction nor had its business commenced prior to STPI registration; that finding was later confirmed by the Karnataka High Court. In view of those precedents and the identical factual matrix, the Tribunal held that the AO erred in denying the deduction and directed that the deduction under section 10A be allowed in respect of the Bangalore unit's profits. [Paras 14]Deduction claimed under section 10A for the Bangalore STP unit is allowed.Exclusion of certain expenses from export turnover and total turnover - Deduction under section 10A for STP units - Alternate relief directing exclusion of specified charges from both export turnover and total turnover for computation of section 10A benefit - HELD THAT: - The assessee alternatively prayed that telecommunications/data link and insurance charges excluded from export turnover should also be excluded from total turnover for computing the section 10A deduction. Applying the reasoning of the Karnataka High Court in Tata Elxsi and in the interest of justice, the Tribunal directed the Assessing Officer to exclude telecommunication and insurance charges from both export turnover and total turnover, thereby granting the assessee the alternative relief without deciding the primary factual contention. [Paras 16]AO directed to exclude telecommunication and insurance charges from both export turnover and total turnover for the purpose of computing section 10A deduction.Final Conclusion: The appeal is allowed: the transfer pricing addition for AY 06 07 is deleted after excluding specified comparables and applying the appropriate adjustments; the section 10A deduction for the Bangalore STP unit is permitted; and the AO is directed to exclude specified telecom and insurance charges from both export and total turnover as an alternative relief. Issues Involved:1. Adjustment of Arm's Length Price (ALP) for international transactions.2. Exclusion of certain comparable companies.3. Deduction under Section 10A of the Income Tax Act.4. Exclusion of certain expenses from export turnover and total turnover.Detailed Analysis:1. Adjustment of Arm's Length Price (ALP) for International Transactions:The dispute centers around the addition made due to the determination of ALP for software development services provided by the assessee to its associated enterprises (AEs). The Transfer Pricing Officer (TPO) selected 26 comparable companies and calculated an arithmetic mean of 25.14%. After a negative working capital adjustment of 1.32%, the adjusted mean was 23.82%. The TPO computed the ALP based on this adjusted mean, resulting in a transfer pricing adjustment of Rs. 8,45,74,857. This adjustment was confirmed by the Dispute Resolution Panel (DRP) and added to the total income by the Assessing Officer (AO). The assessee challenged this adjustment before the Tribunal.2. Exclusion of Certain Comparable Companies:The Tribunal considered the comparability of the 26 companies chosen by the TPO. The assessee argued that 8 of these companies should be excluded based on previous Tribunal decisions, as they were functionally different or had other issues affecting comparability. The Tribunal agreed and excluded the following companies:- Avani Cimcon Technologies Ltd.: Functionally different due to revenue from software products.- Celestial Labs Ltd.: Engaged in research and development, not purely software development.- KALS Information Systems Ltd.: Involved in software products and training.- Accel Transmatic Ltd.: Functionally different and had related party transactions.- Lucid Software Ltd.: Involved in software product development.- Infosys Technologies Ltd.: A giant company with significant intangible assets.- Wipro Ltd.: Involved in diverse services and products.- Tata Elxsi Ltd.: Engaged in niche product development services.Additionally, the Tribunal excluded Thirdware Solutions Ltd. and Helios & Matheson Information Technology Ltd. based on previous decisions, and companies with related party transactions exceeding 15%. Companies with turnovers exceeding Rs. 200 crores were also excluded, following the turnover filter rule.3. Deduction under Section 10A of the Income Tax Act:The assessee claimed a deduction of Rs. 4,08,29,786 under Section 10A for its Bangalore unit. The AO disallowed this, citing that the unit was formed by reconstructing an existing unit. The Tribunal referred to its previous decision and the Karnataka High Court's confirmation, which held that the Bangalore unit was not formed by reconstruction and was eligible for the deduction. The Tribunal directed the AO to allow the deduction.4. Exclusion of Certain Expenses from Export Turnover and Total Turnover:The assessee contested the exclusion of data link expenses and foreign travel expenses from the export turnover while computing the deduction under Section 10A. The Tribunal, citing the Karnataka High Court's decision in CIT v. Tata Elxsi Ltd., directed that these expenses should be excluded from both export turnover and total turnover.Conclusion:The Tribunal allowed the appeal by the assessee, directing the exclusion of certain comparable companies, allowing the deduction under Section 10A, and adjusting the computation of export turnover and total turnover. The significant adjustments and exclusions were based on established legal precedents and functional dissimilarities of the comparable companies.