Tribunal excludes company from comparables, directs re-calculation of ALP. Functional comparability key for Section 10A.

The Tribunal partly allowed the assessee's appeal by excluding Persistent Systems Ltd. from the list of comparables and directed the TPO to recompute the Arms Length Price (ALP) accordingly. The Tribunal dismissed the Revenue's appeal, affirming that functional comparability is crucial and that telecommunication charges should be excluded from both export and total turnover for Section 10A deductions.

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Issues Involved:
1. Determination of Arms Length Price (ALP) for international transactions.
2. Functional comparability of selected companies.
3. Reduction of travel and telecommunication charges from export turnover without reducing the same from total turnover under Section 10A of the Income Tax Act.

Detailed Analysis:

1. Determination of Arms Length Price (ALP) for international transactions:

The primary issue in the appeals by both the assessee and the Revenue revolves around the determination of the ALP in respect of international transactions between the assessee and its Associated Enterprises (AEs). The assessee, a subsidiary of NVIDIA International Inc., provides software development services and is compensated on a cost-plus mark-up basis. The Transfer Pricing Officer (TPO) made an adjustment of INR 136,221,840 to the software development services transaction. The TPO used the Transactional Net Margin Method (TNMM) and selected 14 comparables, whereas the assessee had selected 21 comparables. The TPO computed the ALP by comparing the operating profit margins of the selected comparables, resulting in an arithmetic mean margin of 19.27%.

2. Functional comparability of selected companies:

The CIT(A) rejected three comparables (Tata Elxsi, Infosys Technologies Limited, and Kals Information System Limited) based on functional differences, as per the ITAT order for AY 2009-10 in the assessee’s own case. The CIT(A) also directed the AO/TPO to treat foreign exchange fluctuation as operating in nature and to correct receivable/payable figures. The assessee argued for the inclusion of certain companies, which the CIT(A) rejected based on functional differences, employee cost filters, lack of segmental information, different financial year-end, and extraordinary profit fluctuations.

The assessee raised additional grounds for excluding Larsen & Toubro Infotech Limited, Persistent Systems Limited, and Sasken Communication Technologies Limited, arguing they were not functionally comparable. The Tribunal admitted the additional grounds based on the Special Bench decision in DCIT Vs. Quarks Systems Pvt. Ltd., which allows exclusion of non-comparable companies even if initially selected by the assessee.

The Tribunal specifically addressed the exclusion of Persistent Systems Ltd., citing a prior ITAT decision in Cerner Health Care Solutions Pvt. Ltd. The Tribunal noted that Persistent Systems Ltd. engaged in diversified activities, including product development, and lacked segmental information, making it non-comparable with the assessee.

3. Reduction of travel and telecommunication charges from export turnover without reducing the same from total turnover under Section 10A of the Income Tax Act:

The Revenue's appeal included ground No. 2 regarding whether travel and telecommunication charges should be reduced from the export turnover without reducing the same from the total turnover while allowing deduction under Section 10A. The Tribunal referenced the Karnataka High Court decision in CIT Vs. Tata Elxsi Ltd., upheld by the Supreme Court in CIT Vs. HCL Technologies Ltd., which mandates that whatever is excluded from the export turnover should also be excluded from the total turnover. Consequently, the Tribunal held that telecommunication charges should be excluded from both the export turnover and the total turnover for computing the deduction under Section 10A.

Conclusion:

The Tribunal partly allowed the assessee's appeal by excluding Persistent Systems Ltd. from the list of comparables and directed the TPO to recompute the ALP accordingly. The Tribunal dismissed the Revenue's appeal, affirming that the functional comparability is material and that telecommunication charges should be excluded from both export and total turnover for Section 10A deductions.

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