2015 (11) TMI 1723 - AT - Income Tax

ITAT emphasizes functional comparability, depreciation impact on ALP, upholds 5% tolerance margin.

The ITAT dismissed the revenue's appeal and allowed the assessee's appeal for statistical purposes. The ITAT emphasized the importance of functional ... TPO - comparable selection criteria - Held that:- Assessee is a company engaged in the business of Research, Design and Development of application solutions for semi conductor products, thus companies functionally dissimilar with that of assessee or involved in any extraordinary events like mergers and acquisitions need to deselected from final list of comparable. Issues Involved:1. Selection of Comparable Companies2. Depreciation as Part of Variable Cost3. Application of Tolerance Margin4. Exclusion of Specific Comparable Companies5. Determination of Arm's Length Price (ALP)Detailed Analysis:1. Selection of Comparable Companies:The primary issue pertains to the selection of comparable companies for determining the Arm's Length Price (ALP). The Transfer Pricing Officer (TPO) initially selected several comparables, which the Dispute Resolution Panel (DRP) partially revised by excluding companies like Infosys, L&T Infotech, and Mindtree due to their extraordinary events and high turnover. The DRP directed the TPO to exclude these companies, considering various ITAT orders which emphasized excluding companies with extraordinary events like mergers and acquisitions.2. Depreciation as Part of Variable Cost:The DRP accepted the assessee's contention that the depreciation cost should be considered while evaluating the operating results of comparable companies. The assessee's depreciation rate was significantly higher due to a shorter estimated life span of assets. The DRP, supported by decisions from coordinate benches, directed that depreciation should be excluded from the variable cost for all comparable companies, noting that the method of depreciation impacts the operating results.3. Application of Tolerance Margin:The assessee argued for the application of a 5% tolerance margin as per section 92C(2) of the IT Act. The ITAT upheld this contention, referencing the decision in the case of M/s IHG IT Services (India) Pvt. Ltd. Vs. ITO, which clarified that the benefit of the tolerance margin is available when the variation between the ALP and the actual transaction price does not exceed the tolerance margin.4. Exclusion of Specific Comparable Companies:The assessee pressed for the exclusion of E-Infochips Bangalore Ltd. as a comparable, arguing it was functionally different. The ITAT agreed, noting that E-Infochips was engaged in software development and IT-enabled services, whereas the assessee was involved in research, design, and development of application solutions for semiconductor services. The ITAT found that E-Infochips was not functionally comparable to the assessee.5. Determination of Arm's Length Price (ALP):The ITAT directed the AO to reconsider the ALP by excluding the depreciation cost from the variable cost of comparables and applying the 5% tolerance margin. The AO was instructed to complete the assessment under section 143(3) by determining the taxable income accordingly.Conclusion:The ITAT dismissed the revenue's appeal and allowed the assessee's appeal for statistical purposes. The ITAT emphasized the importance of functional comparability and the impact of depreciation on operating results, directing the AO to adjust the ALP calculation based on these considerations. The ITAT also upheld the application of the 5% tolerance margin, ensuring a fair determination of the ALP.