2013 (9) TMI 191 - AT - Income Tax

Transfer pricing comparables and expense characterisation: related-party filters upheld, reimbursements excluded, software capitalised, deposit write-off allowed

Transfer pricing adjustments concerned exclusion of comparables with related party transactions exceeding 15% of turnover; those comparables were to be ... Transfer pricing adjustments - ALP - Selection of comparables with functional dissimilarities - Turnover filter - Purchase of software, a revenue or capital expenditure – Held that:- Assessing Officer/TPO directed to exclude, after due verification, those comparables from the list with the related party transactions or controlled transactions in excess of 15% of the total revenue for the financial year 2006-07. It is to be mentioned here, Geometric Ltd. is also to be removed from the comparable list, since that company was having RPT at 19.98% (going by assessee's own calculation), however, no argument was raised for its exclusion by the assessee, probably, on account of low margin of Geometric Ltd. Reimbursement of expenses - Held that:- these reimbursements were not received against any specific services rendered by the assessee to its AEs. These were pure cost reimbursements (travel expenses, hotel stay expenses and other related expenditures) which the assessee had incurred on behalf of its AE for administrative convenience and later got reimbursed at cost. Therefore, the DRP has erred in including the reimbursements received for the purpose of calculating the adjustment under section 92CA. - Decided in favor of assessee. Software produce is an enduring benefit to the assessee in the sense that it would accelerate to enhance the income due to its usage in its usage in software programme which was ultimately developed and sold by the assessee - Software produce is a part of profit making apparatus of the assessee which had, subsequently, helped the assessee in conducting its business more proficiently - The assessee had not brought any evidence to controvert the findings of the Revenue that software produce expense is a capital in nature - AO was justified in treating the expenditure on purchase of computer software as capital in nature – Depreciation on it will be provided. - Decided against the assessee. Disallowance of rental deposits written off - Since the assessee had difficulty in recovering the deposit from the landlord, it had filed a suit before the Hon'ble High Court of Karnataka, which was dismissed on the ground that the lease deed was not duly registered. Hence, the assessee wrote off the rental deposit in its books and claimed as deduction while computing business profits of the assessee. The AO has disallowed the same with the contention that the same is not revenue in nature and, hence, not deductible under the Act – Held that:- Relying upon the Mumbai Bench of the Hon’ble Tribunal in the case of United Motors (India) Ltd. v. ITO [2010 (4) TMI 726 - ITAT, MUMBAI], it has been held that the write off of the interest free deposit made by the assessee to the licensor against rental properties was a loss incidental to the business and, hence, the assessee was entitled to claim the same as allowable deduction – Decided in favor of Assessee. Issues: (i) Whether the TPO/DRP's transfer pricing adjustment based on comparables selected by the TPO (including application of turnover filter, functional comparability, related party transaction threshold and working capital adjustments) is sustainable; (ii) Whether reimbursements of expenses received from Associated Enterprises should be included in the operating cost/revenue for ALP determination; (iii) Whether expenditure on purchase of computer software is capital in nature and disallowable as revenue expenditure; (iv) Whether write-off of rental deposit is deductible as a business loss.Issue (i): Whether the comparables selected by the TPO can be retained and the TPO/DRP's ALP adjustment sustained, having regard to turnover filters, functional dissimilarity, related party transactions and required adjustments (including segmental margin and working capital adjustment).Analysis: The Tribunal examined prior coordinate-bench decisions dealing with software development comparability and Dun & Bradstreet based turnover ranges. It accepted exclusion of comparables with turnover substantially above the assessee (applying a turnover filter consistent with earlier decisions), directed exclusion of specified functionally dissimilar comparables identified by precedent, required exclusion of comparables with related party transactions exceeding 15% after verification, and directed that the segmental margin of Megasoft be used instead of entity-level margin; it further directed the AO/TPO to compute ALP applying these directions and to make adjustment only if the assessee's margin falls outside the +/-5% bandwidth in proviso to section 92C(2).Conclusion: The Tribunal upheld in part and modified the TPO/DRP selections: certain high-turnover and functionally dissimilar comparables are to be excluded, RPT >15% comparables are to be excluded after verification, segmental margin for Megasoft is to be used, and ALP is to be reworked by the AO/TPO in accordance with these directions. This results in partial acceptance of the assessee's contentions on comparability.Issue (ii): Whether reimbursements of expenses received from Associated Enterprises should be added to operating revenues/costs for determining ALP under TNMM.Analysis: The Tribunal found the documentary details of reimbursements unclear on record and observed that pure pass-through cost recoveries without mark-up should not be added to the cost base. In view of the lack of specific breakup/clarity, the Tribunal remitted the matter to the Assessing Officer/TPO for detailed verification of the nature of the receipts and directed that pure cost recoveries without any service/mark-up should not be added back.Conclusion: The issue of reimbursements is remitted to the AO/TPO for verification; ground on reimbursements is allowed for statistical purposes (i.e., remand for factual determination in favour of correct treatment based on verification).Issue (iii): Whether expenditure on purchase of computer software is capital in nature and therefore not allowable as revenue deduction.Analysis: On the facts and documents, the Tribunal accepted that the software purchased constituted an enduring benefit forming part of the profit-making apparatus and that depreciation had been allowed; the assessee did not produce evidence to rebut the revenue view that the expenditure was capital in nature.Conclusion: The Tribunal upheld the authorities' treatment and held the expenditure to be capital in nature; the assessee's claim for revenue deduction is rejected.Issue (iv): Whether the write-off of rental deposit (refundable deposit written off after failure to recover) is an allowable deduction as a business loss incidental to trade.Analysis: Relying on precedent where similar deposit write-offs were held to be losses incidental to business, the Tribunal considered that the deposit did not result in acquisition of a capital asset or enduring capital benefit and that the write-off arose in the course of carrying on business.Conclusion: The Tribunal allowed the claim and held the write-off of the rental deposit to be an allowable revenue deduction.Final Conclusion: The appeal is partly allowed: the Tribunal directed exclusion of specified comparables (turnover and functional grounds), exclusion of comparables with RPT>15% after verification, use of segmental margin for Megasoft, remand of the reimbursement issue to the AO/TPO for factual verification, upheld the capital nature of computer software purchase (claim denied), and allowed the rental deposit write-off as a business deduction.