Tribunal Decision on Revenue and Assessee Appeals: Comparable Companies, Working Capital, Section 10A

The Tribunal partly allowed both the Revenue's appeal and the Assessee's cross-objection, making specific inclusions and exclusions of comparable companies and upholding the CIT(A)'s decisions on working capital adjustment and Section 10A computation. The judgment was pronounced on July 17, 2019.

---

---

Issues Involved:
1. Determination of Arm's Length Price (ALP) for software development services.
2. Exclusion and inclusion of certain companies as comparables.
3. Application of turnover filter.
4. Exclusion based on abnormal profits.
5. Application of diminishing revenue filter.
6. Inclusion of companies with different accounting years.
7. Working capital adjustment.
8. Computation of deduction under Section 10A, including exclusion of telecommunication charges from export turnover and total turnover.

Detailed Analysis:

1. Determination of Arm's Length Price (ALP) for software development services:
The primary dispute revolves around the determination of ALP for the software development services provided by the Assessee to its Associated Enterprise (AE), Facetime Communications Inc., USA. The Assessee used the Transaction Net Margin Method (TNMM) as the Most Appropriate Method (MAM), which was accepted by the Transfer Pricing Officer (TPO). The TPO made an adjustment to the price charged in the international transaction, which was challenged by the Assessee before the CIT(A). The CIT(A) provided partial relief, leading to appeals by both the Revenue and the Assessee.

2. Exclusion and inclusion of certain companies as comparables:
The TPO selected 17 comparable companies, but the CIT(A) excluded some and included others. The Revenue appealed against the exclusion of companies like Flextronics Software Services Ltd., iGate Global Solutions Ltd., Infosys Technologies Ltd., L&T Infotech Ltd., and Satyam Computers Services Ltd. based on their high turnover. The Tribunal upheld the CIT(A)'s decision, citing that companies with a turnover above Rs. 200 crores are not comparable to the Assessee with a turnover of Rs. 6.36 crores.

3. Application of turnover filter:
The Tribunal agreed with the CIT(A) that the size and turnover of companies are deciding factors for comparability. Companies with a turnover above Rs. 200 crores were excluded from the list of comparables, aligning with the precedent set by the Bangalore Bench of ITAT in the case of Auto Desk India Pvt. Ltd. Vs. ACIT.

4. Exclusion based on abnormal profits:
The CIT(A) excluded M/s. Exensys Software Solutions Ltd. and Thirdware Solutions Ltd. due to abnormal profits. The Tribunal noted that abnormal profits alone are not grounds for exclusion unless they result from unusual circumstances. Exensys was excluded due to amalgamation, while Thirdware was excluded based on functional non-comparability, as it was a product company, not a software development service provider.

5. Application of diminishing revenue filter:
The Tribunal dismissed this ground as no company was excluded or included based on the diminishing revenue filter, rendering the issue academic.

6. Inclusion of companies with different accounting years:
The CIT(A) included M/s. Quintegra Solutions Ltd., which had a different accounting year. The Tribunal agreed with the Revenue that this company should be excluded, as the Assessee did not object to its exclusion.

7. Working capital adjustment:
The Tribunal upheld the CIT(A)'s direction to allow working capital adjustment, noting that even the TPO allowed it. Such adjustments are necessary for proper comparison of profit margins.

8. Computation of deduction under Section 10A:
The Revenue contested the CIT(A)'s decision to exclude telecommunication charges from both export turnover and total turnover while computing the deduction under Section 10A. The Tribunal upheld the CIT(A)'s decision, referencing the Karnataka High Court's ruling in CIT v. Tata Elxsi Ltd., which mandates that expenses reduced from export turnover should also be reduced from total turnover. This view was further supported by the Supreme Court in CIT v. HCL Technologies Ltd.

Cross-Objection by the Assessee:
The Assessee sought the exclusion of Sankhya Infotech Ltd. and Four Soft Ltd. from the list of comparables. The Tribunal agreed to exclude Sankhya Infotech Ltd., citing its involvement in software product development and low employee cost, consistent with the ITAT Bangalore Bench's decision in DCIT Vs. M/s. Sharp Software Development (India) Pvt. Ltd.

Conclusion:
The Tribunal partly allowed both the Revenue's appeal and the Assessee's cross-objection, making specific inclusions and exclusions of comparable companies and upholding the CIT(A)'s decisions on working capital adjustment and Section 10A computation. The judgment was pronounced on July 17, 2019.

---