Assessee's ALP method flawed; excluded non-comparable units; Section 10AA deduction reduced and reassessed

ITAT Delhi held that the assessee's method of determining ALP for IT-enabled services using certain comparables was flawed, excluding entities with disproportionate scale or functional differences. Captive units with low turnover were not comparable to the assessee's large-scale operations. R. Systems International Ltd. was to be included after adjusting financial year data. Working capital adjustment claims were remanded for fresh consideration. Deduction under Section 10AA was reduced and remitted for reassessment regarding interest income classification. Communication expenses incurred in foreign currency were excluded from export turnover for Section 10AA deduction computation. The tribunal partly allowed the appeal, directing reassessment and exclusion of inappropriate comparables while affirming the need for a fair working capital adjustment.

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Issues Involved:
1. Transfer Pricing Adjustment
2. Inclusion/Exclusion of Comparables
3. Working Capital Adjustment
4. Deduction under Section 10AA of the Income-tax Act, 1961

Detailed Analysis:

1. Transfer Pricing Adjustment:
The primary issue in the appeal is the transfer pricing adjustment of Rs. 6,16,24,726/- made by the AO based on the TPO's proposal and approved by the DRP. The assessee, a wholly-owned subsidiary of Mercer Mauritius Ltd., provides IT and IT-enabled services to its AEs. The dispute concerns the determination of the ALP for IT-enabled services rendered to Mercer (US) Inc., for which the assessee was compensated Rs. 59,19,89,199/-. The assessee used the TNMM method for benchmarking, but the TPO found defects in the TP analysis and chose five comparables, resulting in a proposed adjustment.

2. Inclusion/Exclusion of Comparables:
The assessee contested the exclusion of three comparables and the inclusion of three others initially included by the assessee but later claimed to be non-comparable.

a. Allsec Technologies Ltd.:
The TPO excluded this company due to diminishing sales and export revenues less than 75% of total turnover. However, the tribunal found that Allsec's operating revenue increased in FY 2008-09 and its export revenue was 74.45%. The tribunal held that the exclusion for such a minuscule difference was unjustified and included Allsec in the list of comparables.

b. CG-VAK Software & Exports Ltd.:
The TPO excluded this company based on a turnover filter of less than Rs. 1 crore. The tribunal upheld this exclusion, noting the company's low revenue from BPO services and its status as a captive unit, making it incomparable to the assessee.

c. R. Systems International Ltd.:
The TPO excluded this company due to a different financial year ending. The tribunal directed the TPO/AO to include R. Systems by working out figures relevant to the financial year ending 31.3.09 from the audited accounts.

d. Coral Hub Ltd.:
The tribunal excluded this company due to significant outsourcing (90% of total operating cost), which made it functionally different from the assessee.

e. Cosmic Global Ltd.:
The tribunal excluded this company due to its low revenue from the Accounts BPO segment (Rs. 27.76 lac), making it incomparable to the assessee.

f. Genesys International Corporation Ltd.:
The tribunal excluded this company due to functional incomparability, as it provided geospatial services, unlike the assessee's human resources and payroll services.

3. Working Capital Adjustment:
The tribunal found the authorities' rejection of the working capital adjustment claim unjustified. It directed the TPO/AO to examine the assessee's claim on merits and allow the adjustment if warranted.

4. Deduction under Section 10AA:
The issue had two components: denial of deduction on interest income and reduction of communication expenses from export turnover.

a. Interest Income:
The tribunal held that interest income, if falling under 'Profits and gains of business or profession,' is eligible for deduction under Section 10AA. It remitted the matter to the AO to decide on the nature of interest income and allow deduction accordingly.

b. Communication Expenses:
The tribunal directed that communication expenses should be excluded from both export turnover and total turnover, following the jurisdictional High Court's decision in CIT vs. Genpact India.

Conclusion:
The appeal was partly allowed, with directions to include/exclude certain comparables, consider working capital adjustment, and reassess the deduction under Section 10AA based on the tribunal's findings.

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