Tribunal revises transfer pricing adjustments, excludes certain transactions, costs, and interest, in line with High Court ruling.

The Tribunal partly allowed the appeal, directing the AO/TPO to recalculate the transfer pricing adjustment by excluding transactions with the Canada branch and non-AEs, exclude excess depreciation on the building let out from operating costs, delete the addition of notional interest on security deposits, and reassess the transfer pricing adjustment on the interest-free loan to the AE in accordance with earlier directions and a Delhi High Court judgment.

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Issues Involved:
1. Transfer pricing adjustment on software development services.
2. Inclusion of depreciation on building let out as operating cost.
3. Treatment of hypothetical interest on security deposits as income under Section 28(iv).
4. Transfer pricing adjustment on interest-free loan to associated enterprises (AE).

Detailed Analysis:

1. Transfer Pricing Adjustment on Software Development Services:
The primary issue concerns the addition of Rs. 8,61,31,210/- made by the Assessing Officer (AO) on account of transfer pricing adjustment. The assessee, an Indian company with a branch office in Canada, reported seven international transactions. The Transfer Pricing Officer (TPO) altered some of the comparables chosen by the assessee and computed the arm's length margin at 23.56% of the operating cost, applying it to the total revenue of Rs. 36.63 crore, inclusive of revenues from non-AEs. The Tribunal observed that the TPO wrongly included transactions between the head office in India and the branch office in Canada as international transactions. The Tribunal held that such transactions do not qualify as international transactions under Section 92B(1) of the Income-tax Act, 1961, as they are not between two or more associated enterprises. Consequently, the Tribunal directed the AO/TPO to exclude transactions with the Canada branch and non-AEs while recalculating the transfer pricing adjustment.

2. Inclusion of Depreciation on Building Let Out as Operating Cost:
The second issue pertains to considering depreciation on a building let out as an operating cost. The Dispute Resolution Panel (DRP) directed the TPO to verify and exclude the excess amount of depreciation from the total operating costs. However, the TPO/AO did not adhere to this direction. The Tribunal emphasized that the directions given by the DRP are mandatory under Section 144C(13) and must be followed by the AO. Therefore, the Tribunal set aside the impugned order and remitted the matter to the AO/TPO for passing an order in conformity with the DRP's direction to exclude the excess amount of depreciation.

3. Treatment of Hypothetical Interest on Security Deposits as Income Under Section 28(iv):
The third issue involves the treatment of hypothetical interest on security deposits as income under Section 28(iv). The AO included a sum of Rs. 11,58,822/- as notional interest on an interest-free security deposit received by the assessee. The DRP directed the AO to delete this addition, stating that neither the annual letting value (ALV) of the property can be increased under Section 23 with the notional interest nor can Section 28(iv) be applied. However, the AO still made the addition in the final assessment order. The Tribunal reiterated that the DRP's directions are binding and held that the addition of Rs. 11.58 lakh was not warranted, thus allowing this ground in favor of the assessee.

4. Transfer Pricing Adjustment on Interest-Free Loan to Associated Enterprises (AE):
The final issue concerns the transfer pricing adjustment towards interest on an interest-free loan given by the assessee to its AE. The TPO applied an interest rate of 14% on the loan amount, resulting in a transfer pricing adjustment of Rs. 87,90,467/-. This issue is recurring from earlier years, and the Tribunal had previously remitted the matter for fresh consideration. The Tribunal directed the AO/TPO to re-examine the transfer pricing adjustment in light of the Tribunal's earlier directions and the recent judgment by the Hon'ble Delhi High Court in CIT vs. Cotton Naturals (I) Pvt. Ltd., which states that the currency in which the loan is to be repaid determines the rate of interest. The Tribunal instructed the TPO to compute the rate of interest accordingly.

Conclusion:
The appeal is partly allowed, with the Tribunal directing the AO/TPO to:
1. Recalculate the transfer pricing adjustment by excluding transactions with the Canada branch and non-AEs.
2. Exclude the excess amount of depreciation on the building let out from the operating costs.
3. Delete the addition of notional interest on security deposits.
4. Reassess the transfer pricing adjustment on the interest-free loan to the AE in accordance with the Tribunal's earlier directions and the Delhi High Court's judgment.

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