Ruling clarifies TNMM comparables, Rule 10B(4) data use, section 10A turnover, denies 5% section 92C(2) cushion

ITAT upheld the CIT(A)'s rejection of additional comparables proposed by the assessee, agreeing that companies with related party transactions exceeding 25% of sales and functional differences could not be used under TNMM. It confirmed that only current-year data, with limited exceptions under Rule 10B(4), is permissible, and subsequent period data cannot be used. On section 10A, it approved reducing data link charges from both export turnover and total turnover in line with Sak Soft. However, it reversed the CIT(A) on the 5% adjustment under section 92C(2), holding it inapplicable where ALP is determined by a single method and single price. Both assessee's and Revenue's appeals were partly allowed.

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Issues Involved:
1. Adjustments made under Section 92CA of the Income Tax Act.
2. Rejection of certain comparable cases by the Transfer Pricing Officer (TPO).
3. Use of multiple year data for determining Arm's Length Price (ALP).
4. Working capital adjustments and risk adjustments.
5. Data link charges and their impact on the computation of deduction under Section 10A.
6. Entitlement to the 5% adjustment under Section 92C(2) of the Act.

Detailed Analysis:

1. Adjustments made under Section 92CA of the Income Tax Act:
The main issue in these cross appeals pertains to adjustments made under Section 92CA. The assessee, engaged in software development services, received Rs. 39,04,34,858 from its Associated Enterprises (AEs) and determined the ALP using a transfer pricing study. The TPO rejected ten out of fourteen comparable cases due to substantial related party transactions or functional differences, accepting only four and computing an arithmetic mean of operating profit/cost at 17.66% against 10.56% shown by the assessee. This resulted in an addition of Rs. 2,50,56,927. The CIT(A) upheld the rejection of the ten comparables but allowed a 5% margin benefit under Section 92C(2), reducing the differential adjustment to Rs. 42,82,338.

2. Rejection of certain comparable cases by the Transfer Pricing Officer (TPO):
The TPO rejected ten out of fourteen comparable cases selected by the assessee, which was upheld by the CIT(A). The assessee agreed to the rejection of eight companies, disputing only Aztec Software & Technology Services Ltd. and Quintegra Solutions Ltd. The TPO rejected Aztec due to substantial related party transactions and Quintegra because its financial results were for a different fiscal year. The Tribunal found the CIT(A)'s rejection of these companies justified.

3. Use of multiple year data for determining Arm's Length Price (ALP):
The assessee argued for the use of multiple year data and contemporaneous data available by the due date of filing the return. However, the Tribunal upheld the CIT(A)'s decision, stating that under Rule 10B(4), data should relate to the financial year of the international transaction, with earlier data considered only if it influences the determination of transfer prices.

4. Working capital adjustments and risk adjustments:
The assessee contended that adjustments for working capital and risk differences were necessary. The Tribunal noted that the assessee did not quantify or identify these differences in its transfer pricing documentation and thus could not claim them at this stage. The CIT(A)'s decision to deny these adjustments was upheld, as risk adjustments depend on specific case facts and no thumb rule applies.

5. Data link charges and their impact on the computation of deduction under Section 10A:
The CIT(A) directed the exclusion of data link charges from total turnover, having excluded them from export turnover, based on the Tribunal's decision in the assessee's case for the previous year and the Special Bench decision in Sak Soft Ltd. The Tribunal upheld this view, rejecting the Revenue's contention that Sections 10A and 80HHC are independent and should not be merged.

6. Entitlement to the 5% adjustment under Section 92C(2) of the Act:
The Tribunal concluded that the assessee is not entitled to the 5% adjustment under Section 92C(2) when only one method (TNMM) is applied to determine the ALP. The Tribunal cited the Delhi Bench decision in Perot Systems TSI (India) Ltd. and noted that the CBDT Circular No.12/2001 does not apply as the price variation exceeds 5%. The CIT(A)'s allowance of the 5% adjustment was set aside.

Conclusion:
Both the appeals of the assessee and the Revenue were partly allowed. The Tribunal upheld the CIT(A)'s decisions on rejecting comparable cases, use of single-year data, and exclusion of data link charges from total turnover. However, it set aside the CIT(A)'s allowance of the 5% margin adjustment under Section 92C(2).

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