2020 (9) TMI 1197 - AT - Income Tax

Tribunal Grants Partial Appeals, Emphasizes Legal Principles for Arm's Length Price Determination

The Tribunal partially allowed the appeals, directing exclusions and adjustments while remanding certain issues for reconsideration. The judgment stressed ... TPA - comparable selection - comparability of 7 companies with a SWD service provider such as the Assessee - HELD THAT:- Assessee in engaged in the business of provision of Software Development Services (SWD services), to its wholly owned holding company. In terms of the provisions of Sec.92-A - Companies functionally dissimilar with that of assessee need to be deselected from final list. Risk adjustment while determining ALP - A perusal of the order of the DRP in this regard shows that the DRP has not directed the AO to allow risk adjustment @ 1%, but has only directed the AO to decide the percentage of risk adjustment to be calculated and to take guidance from the decision of the ITAT Bangalore in the case of Hellosoft Pvt. Ltd. [2013 (10) TMI 747 - ITAT HYDERABAD]. Nevertheless there is no basis or discussion on what are the risks and its quantification. Hence, we are of the view that the said direction is not in accordance with law and hence Gr.No.2 raised by the revenue is allowed, in the facts and circumstances of the present case. Negative working capital adjustment - HELD THAT:- The grievance that advances received from AE should be considered as part of payables for computing working capital requirement is also a settled proposition. Since the issue has not been dealt with in proper perspective and there are factual contradictions, we deem it fit and appropriate to remand the issue of working capital adjustment to the TPO/AO for a consideration afresh after opportunity to the Assessee and in the light of the observations made in this order on working capital adjustment. The grievance that advances received from AE should be considered as part of payables for computing working capital requirement is also a settled proposition. Since the issue has not been dealt with in proper perspective and there are factual contradictions, we deem it fit and appropriate to remand the issue of working capital adjustment to the TPO/AO for a consideration afresh after opportunity to the Assessee and in the light of the observations made in this order on working capital adjustment. Computation of deduction u/s 10A - exclusion of telecommunication expenses, insurance charges and foreign exchange loss both from the export turnover and total turnover for the purpose of computation of deduction u/s. 10A - HELD THAT:- It is not in dispute before us that the Hon’ble High Court of Karnataka in the case of CIT v. Tata Elxsi Ltd [2011 (8) TMI 782 - KARNATAKA HIGH COURT] has held that charges/expenses relating to telecommunication, insurance charges and foreign exchange loss should be excluded both from export turnover and total turnover while computing deduction u/s.10A of the Act i.e., whatever is removed from the numerator should also be excluded from the denominator while working total turnover and export turnover for allowing deduction u/s.10A of the Act. The aforesaid decision of the jurisdictional High Court has been upheld by the Hon’ble Supreme Court in the case of CIT v. HCL Technologies Ltd [2018 (5) TMI 357 - SUPREME COURT] Depreciation on the Written Down Value [WDV] of the lease rentals capitalized in AY 2010-11 in respect of which DRP for AY 2010-11 directed the AO to allow depreciation - premise on lease and paid lease rent - HELD THAT: - AO in his draft assessment order dated 30.3.2015 did not disallow the claim of the Assessee for deduction on account of depreciation. On objections by the Assessee before DRP, the DRP directed the AO to give effect to directions of DRP for AY 2010-11 and allow depreciation. AO in his final assessment order which is subject matter of this appeal disallowed a sum of ₹ 1,49,65,386 instead of allowing depreciation on WDV of the sum of ₹ 1,64,45,484/- as directed by the DRP. The sum of ₹ 1,49,65,386 was arrived at by the AO by reducing a sum of ₹ 14,80,094 from the opening WDV of lease rentals of ₹ 1,64,45,484/-. The approach of the AO in the final order of assessment is not accordance with law and in compliance with the directions of the DRP. As per directions of DRP, the AO should have allowed deduction on account of depreciation of ₹ 14,80,094 - We hold and direct accordingly and allow ground. Issues Involved:1. Determination of Arm's Length Price (ALP) for Software Development Services (SWD) and Marketing Support Services (MSS).2. Exclusion of specific comparable companies.3. Computation of working capital adjustment.4. Exclusion of telecommunication expenses, insurance charges, and foreign exchange loss from export turnover and total turnover.5. Disallowance of lease rentals claimed as revenue expenditure.Detailed Analysis:1. Determination of Arm's Length Price (ALP) for SWD and MSS:The Assessee provided Software Development Services (SWD) and Marketing Support Services (MSS) to its wholly-owned holding company, classified as an international transaction under Sec.92B(1) of the Income Tax Act. The Assessee used the Transaction Net Margin Method (TNMM) and selected Operating Profit/Operating Cost (OP/OC) as the Profit Level Indicator (PLI). The Transfer Pricing Officer (TPO) accepted TNMM but rejected many of the Assessee’s comparable companies, identifying others and determining an adjusted mean margin of 26.34%, leading to an addition of Rs. 8,22,35,220 to the Assessee's income.2. Exclusion of Specific Comparable Companies:The Disputes Resolution Panel (DRP) excluded six companies based on a turnover filter of more than Rs. 200 crores but did not agree to exclude others. The Assessee appealed, seeking the exclusion of five additional companies. The Tribunal, referencing previous decisions, upheld the exclusion of these companies due to various reasons such as engagement in diversified activities, revenue from both software services and products, and lack of segmental information.3. Computation of Working Capital Adjustment:The TPO's methodology for computing working capital adjustment was disputed by the Assessee. The Assessee argued that the TPO incorrectly restricted the adjustment and did not consider advances received from the holding company. The Tribunal found several contradictions in the TPO's order and remanded the issue for reconsideration, emphasizing that adjustments should reflect actual working capital differences without arbitrary restrictions.4. Exclusion of Telecommunication Expenses, Insurance Charges, and Foreign Exchange Loss:The Tribunal upheld the exclusion of these expenses from both export turnover and total turnover for the purpose of computing the deduction under Sec.10A, in line with the Karnataka High Court's decision in CIT v. Tata Elxsi Ltd., which was affirmed by the Supreme Court in CIT v. HCL Technologies Ltd.5. Disallowance of Lease Rentals Claimed as Revenue Expenditure:The Assessee claimed depreciation on lease rentals capitalized in the previous assessment year. The AO disallowed the claim contrary to the DRP's directions. The Tribunal directed the AO to allow the depreciation as per the DRP's instructions, correcting the AO's approach.Conclusion:The Tribunal allowed the appeals partly, directing specific exclusions and adjustments, and remanding certain issues for fresh consideration. The judgment emphasized adherence to established legal principles and previous decisions, ensuring accurate computation of ALP, working capital adjustments, and proper allowance of deductions.