2015 (3) TMI 401 - AT - Income Tax

Assessee's transfer pricing adjusted: OP/total-cost PLI fixed at 9%, addition capped at Rs.17,32,27,953; Sec.10A allocations partly upheld

ITAT allowed the assessee's transfer-pricing contentions: OP/total-cost PLI was fixed at 9% (not 6.88%). Several alleged comparables were excluded for ... Transfer pricing adjustment - TPO while working out the Profit Level Indicator (PLI) of the operating cost/total cost, arrived at a percentage of 6.88% - Held that:- Submissions made by the ld. counsel for the assessee have to be accepted and the operating profit to the total cost of the assessee should be adopted at 9% on the basis of the assessee's operating revenue and operating cost. Selection of comparable - We are of the view that the comparables which are sought to be excluded by assessee have been held to be not comparable with the case of software service provider, in as much as these companies did not satisfy the functional similarity test. E.g., in the case of company at Sl.No.2 of the list of comparables chosen by the TPO viz., Avani Cincom Technologies Ltd., this Tribunal had taken a view that income of this company from rendering software services and sale of software was not available and therefore this was rejected as a comparable company. Similarly, in the case of Celestial Labs Ltd., the Tribunal took a view that this company was engaged in R&D activity and cannot be compared with a software service provider. It is thus clear that the reason given by the Tribunal in the cases referred to by the ld. counsel for the assessee will equally apply to the present case also. We therefore accept the submissions made on behalf of the assessee and hold that companies at Sl.No. 1, 2, 3, 10, 12, 14, 24 & 26 be excluded from the list of comparables chosen by the TPO while computing the ALP. It is not in dispute before us that the related party transaction in the case of companies exceed 15% and in view of the decision of the Tribunal in the case of 24/7 Customer.Com (P.) Ltd. [2013 (1) TMI 45 - ITAT BANGALORE] that where the RPT exceeds 15%, such companies should not be taken as comparables, we hold that companies at Sl.Nos. 7 and 11 of the list of the comparables chosen by the TPO be excluded from the list of comparable companies while working out the ALP. ICC International Agencies Ltd. - The functional profile of the assessee, as we have already seen, is only giving support services. Keeping in mind the functions and risk analysis, it is not possible to compare the assessee with ICC International Agencies Ltd. If ICC International Agencies Ltd. is not taken as a comparable, then the margin of the assessee would be well within the OP/Cost PLI of the other comparable companies chosen by the TPO. We accordingly hold that in respect of the international transactions of rendering marketing support services, the price received by the assessee is at arm's length and no adjustment is called for. Ground No.5 raised by the assessee is accordingly allowed. Deduction u/s. 10A - assessee had allocated common expenses between 10A and non-10A units - Held that:- It is seen that the assessee has allocated expenses between 10A and non-10A units wherever they are related to employees on the basis of number of employees employed in 10A unit and non-10A units. Wherever the common expenses are not referable to the employees, they have been wholly allocated to non-10A unit. We are of the view that wherever common expenses are not relatable to employees, they have to be allocated only on the basis of turnover, as that would be the best available yardstick. In the present case will have to be decided on the basis of facts as the STPI unit commenced only in AY 06-07 and there is no past history of allocation of common expenses. As far as recruitment charges are concerned, the AO's reasons for rejecting the same is on the ground that the STPI unit i.e., the Sec.10-A unit was started in July 2006 and therefore majority of employees recruited would be only for the STPI unit. Therefore the AO held that allocating only 25% of total expenditure on training to Sec.10-A unit was not correct. Secondly, the AO held that the details of employees recruited in STPI unit and Non-STPI unit could not be provided by the Assessee and therefore adverse inference had to be drawn. When the basis of allocation is the number of employees of Sec.10A unit, which fact is not seriously disputed the basis of allocation has to be held as proper. The AO has proceeded on the basis that recruitment cost for Sec.10A unit will be much more than Non-Sec.10A unit. This assumption of the AO in our view is without any basis. In any event turnover cannot be the basis on which these expenses have to be allocated. We therefore hold that allocation on the basis of number of employees is proper. Travel and conveyance expenses are concerned, the basis of allocation is on the basis of employees travelling for projects of 10A unit. There can be no objection for this allocation. As far as hotel expenses included in Travel and conveyance expenses is concerned, the basis of allocation is proportionate basis i.e., travel expenditure of 10A unit to the total travel expenditure. As rightly contended on behalf of the revenue when the details of persons travelling for project of 10A unit is available there should be no difficulty in identifying the hotel expenses of employees travelling for project of 10A unit. But allocating such costs on the basis of turnover would also be not appropriate. We are of the view that it would be just and appropriate to set aside the order of the AO on this issue and direct the Assessee to give the details of hotel expenses of employees who travelled for projects of 10A unit and allocate expenses on the basis of available evidence direct or circumstantial. Software licenses are concerned, the basis of allocation on the basis of ratio of average head count of 10A unit to the average head count of all units as a whole. The Assessee has done so because software licenses were used both for 10A project and non-10A unit. In such circumstances, the basis of allocation by the Assessee is held to be proper. Communication expenses are concerned the basis of allocation by the Assessee on the basis of ratio of average head count of the 10A unit to the average head count of all units as a whole is no valid basis. As rightly held by the AO, Communication expenses may be dependent not only on the employee strength but also on the projects allocated to each unit. In the absence of any other details allocating those expenses on the basis of turnover is only accepted method. We therefore are of the view that the AO's basis of allocation has to be upheld. Computer software expenses - revenue v/s capital - Held that:- This issue requires re-examination by the AO in the light of the principles laid down by the Special Bench in the case of Amway India Enterprises [2008 (2) TMI 454 - ITAT DELHI-C], wherein principles to be applied in deciding such issues have been laid down - Decided in favour of assessee for statistical purposes. Issues: (i) Whether the transfer pricing adjustment of Rs. 38,20,29,316 in respect of software development services is justified and, if not, the correct adjustment; (ii) Whether any transfer pricing adjustment is warranted for marketing support services; (iii) Whether allocation of common expenses between Sec.10A (STPI) and non-10A units on the basis of turnover by the AO is correct or the assessee's head-count / other allocations should be accepted; (iv) Whether computer software licence charges of Rs. 2,94,28,480 are revenue in nature or capital and require re-examination.Issue (i): Whether the TPO/DRP addition of Rs. 38,20,29,316 for software development services is sustainable and what adjustment should be made.Analysis: The Tribunal evaluated the PLI computation, accepted that provisions written back should not be treated so as to reduce the assessee's net margin (resulting in an OP/TC of 9% for the assessee), examined the comparables selected by the TPO and excluded those found functionally dissimilar or affected by related party transactions, applied working-capital adjustments, and calculated a revised arithmetic mean of the accepted comparables to determine ALP.Conclusion: The transfer pricing adjustment is reduced and restricted to Rs. 17,32,27,953 in favour of the assessee.Issue (ii): Whether the marketing support services received by the assessee require a TP adjustment of Rs. 1,52,73,728.Analysis: The Tribunal compared the functional profile of the assessee's marketing support activities with the comparables used by the TPO, found the principal comparable (ICC International Agencies Ltd.) functionally dissimilar, and observed that excluding that comparable places the assessee's margin within the range of the remaining comparables.Conclusion: No transfer pricing adjustment is required for marketing support services; the assessee succeeds on this issue.Issue (iii): Whether the AO's apportionment of common expenses between the Sec.10A unit and non-10A unit on the basis of turnover is correct.Analysis: The Tribunal considered the nature of various common expenses, precedents on head-count allocation, the commencement timing of the STPI unit, and found that expenses referable to employees are appropriately allocated by head-count while other common expenses not referable to employees should be allocated on a turnover basis; certain items (hotel expenses) require the assessee to furnish detailed evidence and be reallocated accordingly.Conclusion: The AO's turnover-based reallocation is not wholly sustained; allocation on the basis of number of employees is upheld for employee-related costs, some items are to be reallocated on turnover or on the basis of project-specific evidence Grounds 7 and 8 are partly allowed in favour of the assessee.Issue (iv): Whether computer software licence costs totalling Rs. 2,94,28,480 are revenue in nature or capital expenditure.Analysis: The Tribunal found that the question involves application of principles laid down by the Special Bench (Amway) and requires further examination of facts and classification criteria.Conclusion: The issue is remanded to the Assessing Officer for fresh consideration in accordance with the Special Bench principles; Ground 9 is treated as partly allowed.Final Conclusion: The appeal is partly allowed overall: the software development TP addition is substantially reduced, the marketing support service adjustment is set aside, allocations between 10A and non-10A units are modified in part, and the software licence classification is remitted for fresh adjudication.Ratio Decidendi: Functional comparability and correct computation of the assessee's PLI (including proper treatment of reversals) govern TP adjustments under the arithmetic mean method; functionally dissimilar comparables and unacceptable data obtained under Section 133(6) should be excluded, segmental margins may be used where entity-level figures distort comparability, and allocation of common expenses should follow the most reliable factual basis (e.g., head-count for employee-related costs, turnover or project-specific evidence for other common costs).