Tribunal directs ALP recomputation in international transaction appeal

The Tribunal allowed the assessee's appeal and partly allowed the revenue's appeal, directing the AO/TPO to recompute the ALP of the international transaction. The Tribunal upheld the exclusion of comparables based on functional dissimilarity and directed the inclusion of specific companies, aligning with consistent judicial decisions. The order was pronounced on 21st Oct 2020.

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Issues Involved:

1. Addition made towards transfer pricing adjustment.
2. Whether foreign exchange gains/losses are operating in nature.
3. Justification of the DRP's direction to exclude expenses incurred in foreign currency from both export turnover and total turnover.
4. Relief granted by DRP in respect of addition made on account of transfer pricing adjustment.

Detailed Analysis:

1. Addition Made Towards Transfer Pricing Adjustment:

The assessee, a wholly-owned subsidiary providing software development services, adopted the Transactional Net Margin Method (TNMM) with an Operating Profit/Operating Cost (OP/OC) margin of 11.48%. The TPO, however, selected 13 comparable companies with an average margin of 24.82%, leading to a transfer pricing adjustment of Rs.4.38 crores after a working capital adjustment of 1.26%.

The DRP directed the exclusion of ten comparables, retaining only three. The assessee contested the inclusion of Persistent Systems & Solutions Ltd, Persistent Systems Ltd, and Sasken Communications Technologies Ltd, while seeking the inclusion of R.S. Software Ltd, Evoke Technologies Ltd, and Mindtree Ltd. The Tribunal upheld the exclusion of the seven companies based on precedents set in cases like M/s LG Soft India P Ltd and M/s AMD India Private Limited, confirming the exclusion of diverse and functionally dissimilar companies.

2. Whether Foreign Exchange Gains/Losses are Operating in Nature:

The DRP followed the Tribunal’s decisions in cases like Sap Labs India (P) Ltd and Cisco Systems Services BV, holding that foreign exchange fluctuation gains/losses arising from trade debtors and creditors are operational in nature. This was upheld by the Tribunal, affirming that such gains/losses should be considered operating income/expenses for both the assessee and comparable companies.

3. Justification of DRP's Direction to Exclude Expenses Incurred in Foreign Currency from Both Export Turnover and Total Turnover:

The DRP directed the AO to follow the Karnataka High Court's decision in Tata Elxsi Ltd, which mandates the exclusion of expenses incurred in foreign currency from both export turnover and total turnover. The Supreme Court in CIT vs. HCL Technologies Ltd. confirmed this approach, ensuring the formula for calculating export profits remains workable and consistent. The Tribunal upheld the DRP's decision, aligning with the Supreme Court’s ruling.

4. Relief Granted by DRP in Respect of Addition Made on Account of Transfer Pricing Adjustment:

The Tribunal addressed the revenue's challenge against the DRP's exclusion of ten comparables. The Tribunal upheld the exclusion of seven comparables based on functional dissimilarity and lack of segmental details, consistent with precedents. The Tribunal also directed the inclusion of three companies (Evoke Technologies Ltd, R.S. Software India Ltd, and Mindtree Ltd) as requested by the assessee, following consistent judicial decisions.

Conclusion:

The Tribunal's order resulted in the assessee's appeal being allowed and the revenue's appeal being partly allowed. The Tribunal directed the AO/TPO to recompute the ALP of the international transaction, ensuring compliance with the directions and providing the assessee with an opportunity to be heard. The order was pronounced in the open court on 21st Oct 2020.

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