TPO's turnover filter of Rs.1-200 crores inappropriate; 10 times filter directed for comparable selection

ITAT Bangalore held that TPO's turnover filter of Rs.1 crore to Rs.200 crores for comparable selection was inappropriate, directing application of 10 times turnover filter instead. Ten companies were excluded for excessive turnover and five for functional dissimilarity, leaving only two valid comparables. TPO directed to recompute ALP accordingly. For Section 10A computation, expenses excluded from export turnover numerator must also be excluded from total turnover denominator. Employee stock compensation deduction claim was remanded to AO for verification and proper apportionment between 10A and non-10A units.

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Issues Involved:
1. Arm's Length Price (ALP) determination.
2. Turnover filter application.
3. Functional dissimilarity of comparables.
4. Exclusion of expenses from export turnover.
5. Deduction under Section 10A.
6. Employee Stock Option compensation deduction.

Detailed Analysis:

1. Arm's Length Price (ALP) Determination:
The primary issue was whether the price charged by the assessee to its associated enterprises satisfied the arm's length test under Chapter X of the Income Tax Act, 1961. The Transfer Pricing Officer (TPO) had selected 17 comparable companies to determine the ALP, leading to an upward adjustment under Section 92CA of Rs. 82,26,807. The CIT (Appeals) confirmed this adjustment. The Tribunal found that the turnover filter applied by the TPO was not appropriate, leading to the exclusion of certain companies from the comparables set.

2. Turnover Filter Application:
The Tribunal noted that the TPO's turnover slab of Rs. 1 crore to Rs. 200 crores was inappropriate as it gave unrealistic results. Instead, a turnover filter of 10 times the assessee's turnover was applied. This led to the exclusion of 10 companies from the comparables list. The Tribunal directed the TPO/A.O. to recompute the ALP by considering the turnover filter of 10 times on both sides.

3. Functional Dissimilarity of Comparables:
The assessee sought exclusion of five companies on the grounds of functional dissimilarity. The Tribunal, relying on previous decisions, directed the exclusion of these companies from the comparables list. The Tribunal emphasized that companies engaged in different functions, such as product development or owning significant intangibles, should not be compared with the assessee, which was a software development service provider.

4. Exclusion of Expenses from Export Turnover:
The revenue's appeal raised the issue of excluding expenses from the export turnover while computing the deduction under Section 10A. The Tribunal upheld the CIT (Appeals)'s order, following the Karnataka High Court's decision in CIT v. Tata Elxsi Ltd., which mandated that expenses excluded from the numerator (export turnover) should also be excluded from the denominator (total turnover).

5. Deduction under Section 10A:
The Tribunal reiterated that there should be uniformity in the ingredients of both the numerator and the denominator of the formula for computing the deduction under Section 10A. The Tribunal directed the A.O./TPO to recompute the ALP by considering the benefit under the proviso to Section 92C.

6. Employee Stock Option Compensation Deduction:
The assessee raised an additional ground for the deduction of Employee Stock Option compensation paid to the parent company. The Tribunal noted that this issue had been decided in favor of the assessee for the Assessment Year 2008-09. However, since the relevant details were not examined by the Assessing Officer for the current year, the Tribunal set aside the issue to the Assessing Officer for verification and examination of the relevant records.

Conclusion:
The Tribunal directed the exclusion of certain companies from the comparables list based on turnover and functional dissimilarity. It upheld the exclusion of expenses from the export turnover while computing the deduction under Section 10A. The issue of Employee Stock Option compensation deduction was remanded to the Assessing Officer for verification. The appeals were partly allowed.

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