Transfer-pricing TNMM with 12 comparables yields 6.77% margin and Section 92C ALP adjustment upheld; lease expenses allowed for exports

ITAT, Bangalore upheld a transfer-pricing adjustment using TNMM with a combined set of 12 comparables, finding a differential operating margin of 6.77% and sustaining an ALP adjustment against the assessee. A termination compensation of Rs. 1.05 crores was treated as an extraordinary item and excluded from operating expenses for margin computation, leading to disallowance upheld. Conversely, the tribunal ruled in favour of the assessee on lease-line/high-speed link charges, holding that export turnover adjustments must be reflected in total turnover so such expenses attributable to exports cannot be included.

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Issues Involved:
1. Transfer Pricing Adjustment
2. Disallowance of Compensation Payment
3. Reduction of Lease Line Charges from Total Turnover for Section 10A Deduction

Detailed Analysis:

1. Transfer Pricing Adjustment:
Background:
The assessee, an Export Oriented Unit (EOU) providing software development services to its German parent company, SAP AG, reported a loss. The Transfer Pricing Officer (TPO) revised the operating profit ratio to 5.43% and adopted the Transactional Net Margin Method (TNMM) to determine the Arm's Length Price (ALP), resulting in an ALP adjustment of Rs. 11,42,86,466.

Contentions and Findings:
- Reference to TPO: The assessee argued that the reference to TPO was made without an opportunity to be heard. The Tribunal held that the TPO's reference is part of the assessment procedure and does not violate natural justice as the assessee is heard during the TPO's analysis.
- Selection of Most Appropriate Method (MAM): The assessee contended that the TPO should not switch methods. The Tribunal clarified that the TPO can select the most appropriate method after evaluating all methods.
- Operating Margin Computation: The Tribunal accepted the inclusion of foreign exchange fluctuation gains and exclusion of compensation payment from operating costs, revising the assessee's operating margin to 8.80%.
- Normalization of Super Profits: The Tribunal excluded companies with supernormal profits like Hinduja TMT Ltd. and Aftek Infosys Ltd. from the comparables list.
- 5% Marginal Relief: The Tribunal held that the assessee is entitled to a 5% standard deduction under the old proviso to section 92C(2).

Conclusion:
The Tribunal revised the arithmetic mean of the comparables to 20.57% and adjusted the assessee's operating margin to 13.80% after the 5% standard deduction. The revised differential margin was 6.77%, and the assessing authority was directed to recompute the ALP adjustment accordingly.

2. Disallowance of Compensation Payment:
Background:
The assessee paid Rs. 1.05 crores as compensation for terminating a property purchase agreement and claimed it as a deductible expense.

Contentions and Findings:
- Assessee's Argument: The payment was for discharging a contractual liability and should be treated as revenue expenditure.
- Revenue's Argument: The payment was for establishing capital infrastructure and is capital in nature.
- Tribunal's Decision: The Tribunal held that the payment was for discharging a capital liability and not a revenue liability, thus confirming the disallowance by the lower authorities.

Conclusion:
The Tribunal upheld the disallowance of Rs. 1.05 crores as a capital expenditure.

3. Reduction of Lease Line Charges from Total Turnover for Section 10A Deduction:
Background:
The Assessing Officer reduced the export turnover by Rs. 35,83,000 for lease line charges but did not make a corresponding reduction in the total turnover.

Contentions and Findings:
- Assessee's Argument: The total turnover should be adjusted in the same manner as the export turnover.
- Tribunal's Decision: The Tribunal referred to the ITAT Chennai Special Bench decision in SAK Soft Ltd., holding that adjustments made in the export turnover should reflect in the total turnover.

Conclusion:
The Tribunal upheld the CIT(A)'s direction to exclude lease line charges from the total turnover, dismissing the revenue's appeal.

Summary:
The Tribunal's judgment addressed three main issues: transfer pricing adjustments, the nature of compensation payment, and the treatment of lease line charges for Section 10A deduction. The Tribunal provided a detailed analysis, partially allowing the assessee's appeal on transfer pricing and dismissing the revenue's appeal on lease line charges, while upholding the disallowance of compensation payment as a capital expenditure.

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