2016 (8) TMI 1426 - AT - Income Tax

Appeal partly allowed, directions for adjustments on deductions and Arm's Length Price

The appeal was partly allowed, with directions to the Assessing Officer (AO) and Transfer Pricing Officer (TPO) to adjust the computation of deductions ... Computation of deduction under Section 10A (export turnover and total turnover parity) - quarantine of profits of STPI undertaking and set off of losses of non STPI units in relation to 10A benefit - transfer pricing - comparability and selection of comparable companies under TNMM - working capital and other routine adjustments in determining ALP - application of +/-5% tolerance range under section 92C in arm's length determinationComputation of deduction under Section 10A (export turnover and total turnover parity) - Exclusion of certain foreign currency expenses from export turnover must also be excluded from total turnover when computing deduction under Section 10A. - HELD THAT: - The Tribunal followed the binding decision of the jurisdictional High Court in CIT v. Tata Elxsi Ltd. 349 ITR 98 (Kar) and held that where export turnover (numerator) is computed after excluding expenses attributable to delivery outside India (such as freight, telecommunication, insurance or other foreign exchange expenses), the same components must be excluded from the total turnover (denominator) for computing the 10A deduction. The Tribunal directed the Assessing Officer/TPO to exclude the specified foreign currency expenses both from export turnover and from total turnover while computing the deduction under Section 10A, to preserve parity between numerator and denominator and to give effect to the legislative purpose of the tax incentive. [Paras 3]Allowed - AO/TPO directed to exclude the identified foreign exchange attributable expenses from both export turnover and total turnover for computation of deduction under Section 10A.Quarantine of profits of STPI undertaking and set off of losses of non STPI units in relation to 10A benefit - Deduction under Section 10A to be allowed without setting off domestic/non STPI unit losses against profits of the STPI undertaking. - HELD THAT: - Having considered competing High Court precedents and subsequent legislative amendments to Sections 10A/10B (Finance Act, 2000 and later clarificatory developments), the Tribunal followed the decision in Yokogawa India Ltd. (and related subsequent authorities) and concluded that the income of the 10A unit is to be 'quarantined' and excluded at source for the purpose of computing gross total income. Consequently, profits of the STPI (10A) undertaking should not be set off against losses of non STPI units, and the deduction under Section 10A must be allowed without such set off. The Tribunal directed the AO to allow the assessee's claim accordingly. [Paras 4]Allowed - AO directed to permit deduction under Section 10A without setting off domestic/non STPI unit losses.Transfer pricing - comparability and selection of comparable companies under TNMM - working capital and other routine adjustments in determining ALP - application of +/-5% tolerance range under section 92C in arm's length determination - Several comparable companies selected by the TPO are not functionally comparable and are to be excluded; AO/TPO to recompute ALP from the remaining comparables and apply the +/-5% tolerance range; a specific factual point (Megasoft divisions/margin) is remitted for verification. - HELD THAT: - The Tribunal examined the TPO's comparability analysis company by company, applying established principles on functional comparability, contemporaneous data, segmental disclosures and the impropriety of including extreme or non comparable entities (product owners, R&D/biotech firms, KPO/ITES, consolidated rather than standalone comparatives, non contemporaneous financial year data etc.). On the basis of that review and by following coordinate bench precedents, the Tribunal directed exclusion of numerous companies from the TPO's set of 26 comparables. The Tribunal also held that, after exclusion, the AO/TPO must recompute the ALP from the remaining comparables and consider the benefit of the tolerance (+/ 5%) under the relevant rule/provision. As to the contention regarding Megasoft Ltd. (division wise margin), the Tribunal did not decide finally but set aside that specific point to the AO/TPO to verify in the light of the co ordinate bench decision; similarly, the AO/TPO is tasked to carry out the recomputation and adjustments directed. [Paras 5, 7, 16, 21]Partly allowed - multiple specified comparables excluded; AO/TPO directed to recompute ALP from the revised set of comparables, apply the +/-5% tolerance range, and verify the Megasoft divisional/margin issue on the record.Final Conclusion: The appeal is partly allowed. The Tribunal directed (i) exclusion of specified foreign exchange attributable expenses from both export turnover and total turnover for computing the Section 10A deduction; (ii) allowance of deduction under Section 10A without setting off losses of non STPI units; and (iii) exclusion of numerous comparables from the TPO's list with a direction to the AO/TPO to recompute the ALP from the revised comparables, apply the +/-5% tolerance range, and verify the remitted factual point concerning Megasoft before finalising the transfer pricing adjustment. Issues Involved:1. Exclusion of expenditure incurred in foreign currency from export turnover for Section 10A deduction.2. Deduction under Section 10A without setting off loss incurred by the non-STPI unit.3. Transfer Pricing Adjustment and inclusion/exclusion of certain comparable companies.Issue-wise Detailed Analysis:1. Exclusion of Expenditure Incurred in Foreign Currency from Export Turnover for Section 10A Deduction:The assessee argued that the expenditure incurred in foreign currency should not be deducted from the export turnover as it was not for the delivery of software outside India. The Tribunal referenced the Karnataka High Court's decision in CIT v. Tata Elxsi Ltd. (349 ITR 98), which held that if certain expenses are excluded from the export turnover in the numerator, they should also be excluded from the total turnover in the denominator. The Tribunal directed the Assessing Officer (AO) to exclude the expenses from both export and total turnover while computing the deduction under Section 10A.2. Deduction under Section 10A Without Setting Off Loss Incurred by the Non-STPI Unit:The assessee contended that the deduction under Section 10A should be calculated based on the profits of the STPI unit without setting off the losses of the non-STPI unit. The Tribunal referenced the Karnataka High Court's decision in CIT v. Yokogawa India Ltd. (341 ITR 385), which clarified that the income of the 10A unit should be excluded before arriving at the gross total income of the assessee. The Tribunal followed this precedent and directed the AO to allow the deduction under Section 10A without setting off the domestic losses.3. Transfer Pricing Adjustment and Inclusion/Exclusion of Certain Comparable Companies:The assessee challenged the Transfer Pricing Officer's (TPO) selection of comparables and the resulting adjustments. The Tribunal considered the functional comparability of various companies and made the following decisions:- Genysis International Corporation Ltd.: Rejected due to revenue from ITES and lack of segmental results.- Hyper Soft Technology Ltd.: Rejected as it was a software product and trading company.- VGL Software Limited: Rejected due to lack of financial data and response to the TPO's notice.- Accel Transmatics Ltd.: Rejected based on previous Tribunal decisions highlighting its diverse activities.- Avani Cincom Ltd.: Rejected due to revenue from software products and lack of segmental details.- Celestial Labs Ltd.: Rejected as it was primarily a research and development company.- Persistent Systems Ltd., e-Zest Solutions Ltd., Thirdware Software Solutions Ltd.: Rejected based on previous Tribunal decisions and functional differences.- Flextronics Software Systems Ltd.: Accepted as there was no substantial reason for exclusion.- Helios & Matheson Information Technology Ltd.: Rejected due to functional differences and previous Tribunal decisions.- i-Gate Global Solutions Ltd.: Accepted as no substantial reason for exclusion was found.- Ishir Infotech Ltd.: Rejected due to failure of the employee cost filter.- KALS Information Systems Ltd.: Rejected due to functional differences and previous Tribunal decisions.- Megasoft Ltd.: Issue set aside for verification of the correct operating margin.- Mindtree Ltd.: Accepted as no substantial reason for exclusion was found.- R S System International Ltd.: Rejected due to different financial year.- Sasken Communication Technologies Ltd.: Rejected based on previous Tribunal decisions.- Infosys Ltd., Wipro Ltd., Tata Elxsi Ltd.: Rejected due to brand value, size, and functional differences.The Tribunal directed the AO/TPO to recompute the Arm's Length Price (ALP) from the remaining set of comparables and consider the benefit of the +/- 5% range as per Section 92C.Conclusion:The appeal was partly allowed, with directions to the AO/TPO to adjust the computation of deductions and ALP based on the Tribunal's findings on the comparability of companies and the correct interpretation of Section 10A.