Tribunal directs reassessment on ALP adjustment & disallowances, stresses accurate expense computation

The Tribunal partly allowed the appeal, directing the AO to re-compute the ALP adjustment and reconsider disallowances based on specific guidelines. It emphasized providing the assessee with cross-examination opportunities and accurate expense computation. The Tribunal highlighted the need for proper comparables selection and exclusion of certain expenses from turnover calculations.

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Issues Involved:
1. Addition to total income by way of adjustment to the Arms' Length Price (ALP) for international transactions.
2. Exclusion of expenses incurred in foreign currency from export turnover for computing deduction under section 10A.
3. Disallowance of research and development expenses under section 37.
4. Disallowance of provision for building registration charges and provision towards foreign travel expenses.
5. Levy of interest under section 234B of the Act.

Issue-wise Detailed Analysis:

1. Adjustment to ALP:
The assessee, engaged in providing software research & development services to its AE, Versata International Inc., USA, contested the adjustment to ALP made by the TPO. The TPO had rejected 20 out of 28 comparables proposed by the assessee and added 18 new comparables, resulting in an adjusted arithmetic mean of 24.35%. This led to an addition of Rs. 6,20,48,644 to the assessee's income. The Tribunal addressed several specific objections:

- Turnover Filter: The Tribunal agreed with the assessee that companies with a turnover exceeding Rs. 200 crores should be excluded from the list of comparables, citing the principle that size impacts comparability. Consequently, companies like Infosys Technologies Ltd., Wipro Ltd., and others were excluded.

- Use of Information u/s 133(6): The Tribunal noted that the TPO relied on information obtained through notices u/s 133(6) without providing the assessee an opportunity to cross-examine the parties. The Tribunal emphasized that such information should be shared with the assessee, and cross-examination should be allowed if requested.

- Improper Selection of Comparables: The Tribunal found that certain companies like Megasoft Ltd., Avani Cimcon Technologies Ltd., Celestial Labs Ltd., KALS Information Systems Ltd., and Accel Transmatic Ltd. were improperly included as comparables. For instance, Megasoft Ltd.'s segmental margin of 23.11% (software services segment) was deemed appropriate for comparison rather than the entity-level margin of 60.23%.

- Rejection of Assessee's Comparables: The Tribunal upheld the TPO's rejection of certain comparables proposed by the assessee, such as Indium Software (India) Ltd. and E2E Infotech Ltd., based on valid grounds like functional dissimilarity and insufficient details.

The Tribunal directed the AO to re-compute the ALP adjustment based on the revised set of comparables, resulting in an arithmetic mean of 17.508%.

2. Exclusion of Expenses from Export Turnover:
The Tribunal addressed the exclusion of Rs. 1,78,58,079 incurred in foreign currency from export turnover, emphasizing that the assessee was engaged in software development, not rendering technical services. Additionally, Rs. 24,29,913 for telecommunication and insurance expenses were excluded from export turnover. The Tribunal reiterated that expenses reduced from export turnover should also be reduced from total turnover.

3. Disallowance of R&D Expenses:
The assessee's claim of Rs. 1,76,98,160 as research and development expenses was disallowed by the AO, considering it as capital expenditure. The Tribunal noted that these expenses were for developing websites and should be considered as revenue expenditure. The Tribunal remanded the issue back to the AO for fresh consideration, emphasizing the need to examine the nature of expenses.

4. Provision for Building Registration Charges and Foreign Travel Expenses:
- Building Registration Charges: The Tribunal directed the AO not to tax the provision for building registration charges in AY 09-10, as it was already disallowed in the current year.
- Foreign Travel Expenses: The Tribunal directed the AO to re-examine the provision for foreign travel expenses in light of the Supreme Court's decision in Bharat Earth Movers v. CIT, ensuring the reasonableness and consistency of the provision.

5. Levy of Interest u/s 234B:
The Tribunal noted that the levy of interest under section 234B is consequential and directed the AO to provide appropriate relief.

Conclusion:
The Tribunal partly allowed the assessee's appeal, directing the AO to re-compute the ALP adjustment and reconsider the disallowances based on the Tribunal's guidelines. The Tribunal emphasized the importance of providing the assessee with opportunities for cross-examination and ensuring accurate computation of expenses and adjustments.

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