Use current-year comparables in transfer pricing; exclude anomalous loss-makers; related-party comparables allowed; ISP fees as technical services; 15% disallowance upheld.

ITAT held that transfer-pricing comparability must use data of the financial year in which the international transaction occurred (with preceding two years usable only if relevant), upholding the TPO's use of the current year data. Abnormal loss-making and anomalous comparables (including firms with atypical employee-cost ratios) were to be excluded; certain comparables were directed to be included. Related-party transactions were not automatically disqualified on the facts. Segmental data may be used for net-margin computation. Payments to an ISP involving technical personnel were treated as fees for technical services, attracting TDS consequences and disallowance. An ad-hoc 15% disallowance was upheld for failure to produce records.

---

---

Issues Involved:
1. Reduction of communication expenses from export turnover for computing deduction under section 10A.
2. Determination of Arm's Length Price (ALP) for international transactions.
3. Selection and rejection of comparables for transfer pricing.
4. Adjustment towards working capital differences.
5. Exclusion of communication charges from export turnover.
6. Disallowance of expenditure for internet services utilized from VSNL.
7. Ad-hoc disallowance of 15% of expenditure excluding certain charges.
8. Additional ground regarding additions inflating business income qualifying for exemption under section 10A.

Detailed Analysis:

1. Reduction of Communication Expenses from Export Turnover:
The Assessing Officer (AO) excluded communication expenses from the export turnover while computing the deduction under section 10A. This was based on the definition of 'export turnover' in clause (iv) to Explanation-2 to section 10A, which excludes freight, telecommunication charges, and insurance attributable to the delivery of articles outside India. The CIT(A) confirmed this reduction but also ruled that these expenses should be excluded from the total turnover as well. This approach was upheld by the Tribunal, aligning with the decision in ITO v. Sak Soft Ltd. [121 TTJ (Chennai) (SB) 865].

2. Determination of Arm's Length Price (ALP):
The AO referred the determination of ALP to the Transfer Pricing Officer (TPO) who adjusted the ALP of international transactions, leading to an addition of Rs. 4,68,54,433 to the assessee's income. The TPO used contemporaneous data from the financial year 2003-04, excluding some comparables provided by the assessee and including others. This approach was justified under Rule 10B(4) of the Income-tax Rules, 1962, which mandates using data from the relevant financial year.

3. Selection and Rejection of Comparables:
Several comparables were disputed by the assessee:
- Rejected by TPO but disputed by Assessee: Tata Services Ltd., Ace Software Exports Ltd., C.S. Software Enterprises Ltd., MCS Ltd., Mukund Engineers Ltd., F.I. Sofex Ltd., Vans Information Ltd., Suprawin Technologies Ltd., Tulsyan Technologies Ltd.
- Accepted by TPO but rejected by Assessee: Ultramarine & Pigments Ltd., Vishal Information Technologies Ltd., Wipro BPO Ltd., Spanco Telesystems & Solutions Ltd.
The Tribunal directed the AO to reconsider certain comparables based on functional similarities, segmental data, and exclusion criteria for loss-making companies and those with extraordinary profits. The Tribunal emphasized the importance of using only operating profits for comparability and excluded companies with significant functional differences or those operating on a no-profit-no-loss basis.

4. Adjustment Towards Working Capital Differences:
The Tribunal allowed the assessee's plea for adjustment towards working capital differences at 2%, in line with the decisions in Logix Micro Systems Ltd. v. Asstt. CIT and Tally Solutions Pvt. Ltd. v. DCIT.

5. Exclusion of Communication Charges from Export Turnover:
The Tribunal reiterated that communication charges should be excluded from both export turnover and total turnover for computing deduction under section 10A, as decided in earlier paras and supported by the Special Bench decision in Sak Soft Ltd.

6. Disallowance of Expenditure for Internet Services Utilized from VSNL:
The AO disallowed Rs. 13,09,362 for internet services from VSNL, treating it as fees for technical services requiring tax deduction at source (TDS). The Tribunal upheld this disallowance, distinguishing it from the Skycell Communications Ltd. case and emphasizing the involvement of human skill in providing such services.

7. Ad-hoc Disallowance of 15% of Expenditure:
The AO disallowed 15% of certain expenditures due to the assessee's failure to produce books of accounts and vouchers for verification. The Tribunal upheld this disallowance, noting the assessee's inability to justify the expenses during the assessment proceedings.

8. Additional Ground Regarding Additions Inflating Business Income Qualifying for Exemption under Section 10A:
The Tribunal admitted the additional ground and ruled in favor of the assessee, relying on the Bombay High Court decision in CIT v. Gem Plus Jewellery India Ltd., which held that additions made under the business head should qualify for exemption under section 10A.

Conclusion:
The appeals were partly allowed, with the Tribunal providing detailed directions on the treatment of comparables, adjustments for working capital differences, and the computation of deductions under section 10A. The Tribunal emphasized the need for functional comparability and the proper application of transfer pricing regulations.

---