Tribunal revises transfer pricing & section 10A deduction, excludes comparables.

The Tribunal partly allowed the appeal, directing a fresh computation of the arm's length price for the transfer pricing adjustment and upholding the reduction of communication expenses from export turnover for section 10A deduction. The Tribunal excluded certain comparable companies from the transfer pricing analysis due to functional dissimilarities and other factors, leading to a revised ALP calculation. The decision was pronounced on 22.01.2015.

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Issues Involved:
1. Transfer pricing adjustment.
2. Reduction of communication expenses from export turnover for section 10A deduction.

Issue-wise Detailed Analysis:

1. Transfer Pricing Adjustment:
The primary issue was the addition of Rs. 7,03,80,590/- due to transfer pricing adjustment. The assessee, a wholly-owned subsidiary of Global Logic, US, engaged in software development services, reported an international transaction worth Rs. 93,64,04,329/-. The assessee used the transactional net margin method (TNMM) with a profit level indicator (PLI) of operating profit to total cost (OP/TC) to justify that its international transaction was at arm's length price (ALP). The assessee declared an operating profit margin of 13.34%, compared to the average operating profit margin of 14.53% from selected comparable companies, falling within the permissible range of +/- 5%.

The Transfer Pricing Officer (TPO) selected 26 comparable companies, leading to an arithmetic mean margin of 23.47% after working capital adjustments, resulting in a proposed transfer pricing adjustment of Rs. 7,03,80,590/-. The assessee's objections before the Dispute Resolution Panel (DRP) were unsuccessful, and the Assessing Officer (AO) made the addition.

The assessee argued against the inclusion of certain comparable companies, referencing decisions in similar cases (Motorola Solutions India Pvt. Ltd. and Toluna India Pvt. Ltd.). The Tribunal analyzed the functional profiles of these companies and concluded that the assessee's activities were similar to those of Motorola and Toluna. Consequently, the Tribunal excluded several companies from the final list of comparables based on functional dissimilarities and other factors:

- Avani Cimcon Technologies Ltd.: Excluded due to high operating margins and involvement in software products without segmental break-up.
- Celestial Bio Labs Ltd.: Excluded due to involvement in bio-pharma, biotech manufacturing, and lack of segmental information.
- Flextronics Software Systems Ltd.: Excluded due to inclusion of software products in the segment considered.
- Helios and Matheson Information Technology Ltd.: Excluded due to engagement in ITES BPO services and other non-comparable activities.
- Infosys Ltd.: Excluded due to significant differences in risk profile, scale, and ownership of branded/proprietary products.
- KALS Information Systems Ltd.: Excluded due to revenues from training activities without segmental break-up.
- Lucid Software Ltd.: Excluded due to involvement in software products and unique amortization methods.
- Megasoft Ltd.: Excluded due to significant revenue from software products.
- Persistent Systems Ltd.: Excluded due to mergers and acquisitions during the year.
- Sasken Communications Ltd.: Excluded due to acquisitions and mergers.
- Tata Elxsi Ltd.: Excluded due to involvement in integrated hardware and packaged software solutions.
- Wipro Ltd.: Excluded due to significant differences in risk profile, nature of services, and ownership of proprietary products.

The Tribunal directed the AO/TPO to recompute the ALP of the international transaction, excluding the aforementioned companies and providing the assessee a reasonable opportunity of being heard.

2. Reduction of Communication Expenses from Export Turnover for Section 10A Deduction:
The second issue involved the reduction of 100% communication expenses from the export turnover for the purposes of section 10A deduction. The AO reduced communication expenses amounting to Rs. 43.44 lakh from both the 'export turnover' and the 'total turnover' while computing the deduction under section 10A. The assessee's contention that only 20% of telephone and internet expenses should be attributed to the delivery of software was rejected.

The Tribunal upheld the AO's decision, referencing a similar issue in the assessee's own case for AY 2006-07, where the Tribunal had affirmed the AO's view. The Tribunal found no distinguishing facts for the year in question and thus upheld the impugned order on this issue.

Conclusion:
The appeal was partly allowed for statistical purposes, with the Tribunal directing a fresh computation of the ALP for the transfer pricing adjustment and upholding the reduction of communication expenses from the export turnover for section 10A deduction. The order was pronounced in the open court on 22.01.2015.

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