2019 (8) TMI 1775 - AT - Income Tax

Tribunal decision: Adjustments to income, comparables exclusion, foreign exchange gains, deductions under section 10A

The Tribunal upheld the addition to the Appellant's total income on account of adjustment in the arm's length price of software development and IT enabled ... TP Adjustment - allowing foreign exchange gain/loss as operating revenue for computing margins of comparables under both segments - HELD THAT:- It is undisputed fact that, income earned by assessee/comparable is from international transaction with its AE’s, and is received in foreign exchange currency. Further gain or loss due to foreign exchange fluctuation can be computed only on accrual of income by assessee/comparable. We cannot accept contention of Ld.CIT DR that fluctuation must relate to income earned from international transaction under consideration earned during the year. The moment there is no dispute regarding nexes with income earned and foreign exchange fluctuation, it has to be considered as operating revenue. Thus respectfully following decisions of this Tribunal in case of SAP Labs India Pvt. Ltd. [2010 (8) TMI 676 - ITAT, BANGALORE] and Triology Ebusiness software India Pvt Ltd. [2011 (6) TMI 392 - ITAT BANGALORE] we direct Ld.AO/TPO to consider gain/loss earned by comparable due to foreign exchange fluctuation as operating revenue for computing its margin.We therefore do not find any infirmity in the view taken by Ld. CIT (A) and the same is upheld. Computation of deduction under section 10 A - HELD THAT:- As relying on HCL TECHNOLOGIES LTD. [2018 (5) TMI 357 - SUPREME COURT] deduction of right, telecommunication and insurance attributable to the delivery of computer software under section 10 A of the act are allowed only into export turnover but not from the total turnover then, it would give rise to an inadvertent, unlawful, meaningless and illogical result which would cause grave injustice to the respondent which could have never been the intention of the legislature. Even in common parlance, when the object of the formalised to arrive at the profit from export business, expenses excluded from export turnover have to be excluded from total turnover also. Otherwise, any other interpretation makes the formula unworkable and apps erred. Hence, we are satisfied that such deduction shall be allowed from the total turnover in same proportion as well. Comparable selection - functional dissimilarity - HELD THAT:- Companies functionally dissimilar with that of assessee as contract service provider for software development service need to be deselected from final list. Issues Involved:1. Addition on account of adjustment in the arm's length price (ALP) of software development services and IT enabled services transactions.2. Acceptance and rejection of comparables in the economic analysis for determining ALP.3. Use of financial year data for ALP determination.4. Application of various quantitative and qualitative filters for comparability analysis.5. Inclusion of companies with abnormal profits as comparables.6. Application of employee cost filter.7. Consideration of foreign exchange fluctuation gain as operating in nature.8. Working capital adjustment and its computation.9. Risk profile adjustments.10. Impact of tax holiday under section 10A on transfer pricing provisions.11. Imposition of interest under section 234B.12. Initiation of penalty proceedings under section 271(1)(c).13. Computation of deduction under section 10A.Detailed Analysis:1. Addition on Account of Adjustment in ALP:The CIT(A) confirmed the addition of Rs. 2,88,48,573 and Rs. 1,67,67,670 made by the AO/TPO to the total income of the Appellant on account of adjustment in the ALP of the provision of software development services and IT enabled services transactions, respectively. The Tribunal upheld the CIT(A)'s decision.2. Acceptance and Rejection of Comparables:The CIT(A) upheld the action of the AO/TPO in rejecting certain comparables identified by the Appellant. The Tribunal directed the exclusion of specific comparables such as Infosys Ltd, Persistent Systems Ltd, Larsen and Toubro Infotech Ltd, Bodhtree Consulting Ltd, Tata Elxsi Ltd (segmental), and KALS Information Systems Ltd due to functional dissimilarities and other factors. It also directed the inclusion of comparables like Aztec Soft Ltd, CG-VAK Software and Exports Ltd, and Quintegra Solutions Ltd.3. Use of Financial Year Data:The CIT(A) upheld the AO/TPO's use of only FY 2008-09 data for determining the ALP, which was not available to the Appellant at the time of complying with transfer pricing documentation requirements. The Tribunal did not find any infirmity in this approach.4. Application of Various Filters:The CIT(A) upheld the AO/TPO's application of different quantitative and qualitative filters, such as turnover less than Rs. 1 Crore, different accounting year, and earnings greater than 75% of sales. The Tribunal directed the exclusion of comparables that did not meet these filters.5. Inclusion of Companies with Abnormal Profits:The CIT(A) confirmed the inclusion of companies reflecting abnormal profits as comparables. The Tribunal directed the exclusion of such companies, emphasizing the need for functional similarity and the absence of extraordinary events.6. Application of Employee Cost Filter:The CIT(A) upheld the AO/TPO's rejection of certain comparables based on the employee cost filter. The Tribunal directed the exclusion of comparables that did not meet this criterion.7. Consideration of Foreign Exchange Fluctuation Gain:The CIT(A) allowed the inclusion of foreign exchange gain/loss as operating revenue for computing the margins of comparables. The Tribunal upheld this decision, following precedents like SAP Labs India Pvt. Ltd. vs ACIT and Triology E-business Software India Pvt. Ltd. vs DCIT.8. Working Capital Adjustment:The CIT(A) rejected companies for which working capital adjustment resulted in a reduction of profit margins by more than 4%. The Tribunal directed the AO/TPO to provide appropriate working capital adjustments to comparables to remove differences between them and the assessee.9. Risk Profile Adjustments:The CIT(A) held that no further adjustments were necessary once the AO/TPO granted working capital adjustment. The Tribunal upheld this view.10. Impact of Tax Holiday under Section 10A:The CIT(A) ignored the fact that the Appellant was availing tax holiday under section 10A, which negates the motive to shift profits out of India. The Tribunal did not find any merit in this argument.11. Imposition of Interest under Section 234B:The CIT(A) confirmed the imposition of interest under section 234B. The Tribunal did not provide any specific ruling on this issue.12. Initiation of Penalty Proceedings under Section 271(1)(c):The CIT(A) held that the initiation of penalty proceedings under section 271(1)(c) was premature. The Tribunal upheld this view.13. Computation of Deduction under Section 10A:The CIT(A) directed the AO to compute the deduction under section 10A by excluding telecommunication expenses and expenses incurred in foreign currency from the total turnover, following the decision of the Karnataka High Court in CIT vs Tata Elxsi Ltd. The Tribunal upheld this direction, following the Supreme Court's decision in CIT vs HCL Technologies Ltd.Conclusion:The Tribunal provided a detailed analysis of each issue, directing the exclusion of certain comparables, upholding the inclusion of foreign exchange gains/losses as operating revenue, and confirming the computation of deductions under section 10A as per judicial precedents. The appeal filed by the revenue was dismissed, and the cross-objection and appeal filed by the assessee were partly allowed.