AO/TPO Must Adjust Telecommunication and Travel Expenses for Section 10A Deduction, Review Transfer Pricing Methods

The ITAT Bangalore directed the AO/TPO to reduce telecommunication and travel expenses from both export and total turnover for section 10A deduction, ensuring parity. The Tribunal restored the issue of the appropriate transfer pricing method (CPM/CUP vs. TNMM) for fresh consideration, referencing prior decisions. Several companies were excluded as comparables due to turnover or functional dissimilarity, while thirteen companies were retained. The AO/TPO was instructed to consider segmental margins for Mega soft Ltd and to verify whether professional fees paid by Ishir InfoTech relate to outsourced work, affecting comparability filters. Foreign exchange gains/losses must be treated consistently for the assessee and comparables. The working capital adjustment required reconciliation and was remitted for verification. Finally, if margin differentials exceed the 5% threshold under section 92C(2), appropriate transfer pricing adjustments are to be made.

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Issues Involved:

1. Re-computation of deduction under section 10A of the Act.
2. Transfer Pricing adjustments.

Detailed Analysis:

I. Re-computation of Deduction under Section 10A (Ground Nos. 2 & 3):

The Assessing Officer (AO) had re-computed the deduction under section 10A by reducing foreign exchange expenditure amounting to Rs. 10,18,13,341 from the export turnover without making a corresponding adjustment to the total turnover. The assessee argued that these expenses should not be reduced from the export turnover. Alternatively, if reduced, the same should also be reduced from the total turnover. This alternative submission was supported by the jurisdictional High Court in CIT v Tata Elxsi Ltd. (2012) 349 ITR 98 (Kar.), and in the assessee's own case for AY 2002-03. The Tribunal directed the AO to reduce Rs. 10,18,13,341 from both export turnover and total turnover while computing the deduction under section 10A, allowing ground no.3 and dismissing ground no.2 as unnecessary to adjudicate.

II. Transfer Pricing (Ground Nos. 5 to 16):

A. Methodology for Determining ALP (Ground Nos. 6 & 7):

The assessee used the Comparable Uncontrolled Price (CUP) and Cost Plus Method (CPM) to determine the Arms Length Price (ALP), comparing man-hour rates charged by major software companies in India. The Transfer Pricing Officer (TPO) rejected this, applying the Transaction Net Margin Method (TNMM) instead. The Tribunal restored the issue to the AO/TPO for fresh consideration, directing them to evaluate whether CPM/CUP is the most appropriate method and whether foreign exchange gain/loss should be considered as part of operating revenue.

B. Exclusion of Certain Comparables Based on Turnover and Functional Dissimilarity (Ground Nos. 10, 11, 12):

The Tribunal excluded eight companies from the TPO's list of comparables due to their high turnover exceeding Rs. 200 crores, following the reasoning in previous Tribunal decisions such as Trilogy E-Business Software India Pvt. Ltd. and Telcordia Technologies India Pvt. Ltd. Additionally, five companies were excluded due to functional dissimilarity, with detailed reasons provided for each exclusion based on prior Tribunal findings.

C. Specific Adjustments and Re-computation:

1. Foreign Exchange Gains/Losses (Ground No. 12):
The Tribunal directed that foreign exchange gains/losses should be considered as part of the operating revenue or cost for both the assessee and the comparables, following the decision in Trilogy E-Business.

2. Incorrect Margin Computation (Ground No. 13):
The Tribunal acknowledged the assessee's grievance regarding arithmetical mistakes in the TPO's order and directed the TPO to address the issue expeditiously.

3. Working Capital Adjustment (Ground No. 14):
The Tribunal remitted the issue back to the AO/TPO to verify and rectify the alleged errors in the working capital adjustment.

4. Risk Adjustment (Ground No. 15):
The Tribunal remanded the issue back to the AO/TPO to decide afresh, consistent with the findings in the case of M/s. Insilica Semiconductors India Pvt. Ltd v. ITO.

Conclusion:

The Tribunal directed the AO/TPO to re-compute the ALP in accordance with the Tribunal's directions. If the differential in the margin of the assessee and the comparables exceeds the 5% bandwidth, an adjustment is required. The appeal was partly allowed as indicated, and the order was pronounced on February 22, 2013, in Bangalore.

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