Tribunal ruling on deduction under Section 10A & exclusion of expenses from turnover

The Tribunal decided in favor of the assessee regarding the exclusion of communication expenses from turnover for deduction under Section 10A, citing a Karnataka High Court decision. The issue of excluding certain companies based on size and turnover was partly allowed in favor of the revenue. The exclusion of M/s Celestial Biolabs Ltd. was decided in favor of the revenue. The rejection of the employee cost filter was in favor of the revenue. The Tribunal dismissed the revenue's appeal on the diminishing revenue and different financial year filters. The Tribunal directed the exclusion of certain companies from the set of comparables and upheld the adjustment to interest on external commercial borrowings.

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Issues Involved:
1. Exclusion of communication expenses from both export turnover and total turnover for computing deduction under Section 10A.
2. Exclusion of certain companies as comparables based on size and turnover.
3. Exclusion of M/s Celestial Biolabs Ltd. due to high profit margin.
4. Rejection of the employee cost filter by the CIT (Appeals).
5. Rejection of the diminishing revenue filter and different financial year filter by the CIT (Appeals).
6. Rejection of M/s Avani Cimcon Technologies Ltd. as a comparable.
7. Rejection of M/s Kals Information Systems Ltd. as a comparable.
8. Cross objections by the assessee regarding the rejection of TP documentation and the use of data at the time of assessment proceedings.
9. Exclusion of 12 companies from the set of comparables by the assessee.
10. Adjustment to the payment of interest on external commercial borrowings.

Detailed Analysis:

1. Exclusion of Communication Expenses:
The Tribunal found that the issue of excluding communication expenses from both export turnover and total turnover while computing deduction under Section 10A is covered in favor of the assessee by the decision of the Karnataka High Court in CIT Vs. Tata Elxsi Ltd. 349 ITR 98 (Kar). The decision is binding on the Bangalore Bench of the Tribunal. Therefore, this issue was decided against the revenue and in favor of the assessee.

2. Exclusion of Certain Companies Based on Size and Turnover:
The Tribunal noted that the assessee conceded that size and turnover are not relevant factors for deciding functional comparability. The exclusion and inclusion of various companies would be decided based on functional comparability and not on the turnover filter. Consequently, the Tribunal partly allowed the revenue's ground on this issue.

3. Exclusion of M/s Celestial Biolabs Ltd.:
The Tribunal held that high profit or loss alone cannot be the criteria for inclusion or exclusion of a company in the set of comparables. However, if an extraordinary event resulted in abnormal high profit or loss, it could be a relevant factor for exclusion. This issue was decided in favor of the revenue, and the functional comparability of this company would be considered along with other comparable companies challenged by the assessee.

4. Rejection of the Employee Cost Filter:
The Tribunal found that the employee cost at 25% is a relevant factor for selecting comparables to ensure that the business model is similar to the assessee. In the service industry, employee cost is a significant component, and if it is less than 25%, it indicates outsourcing of business activities. The Tribunal found the CIT (Appeals) order on this issue erroneous and set it aside, deciding this ground in favor of the revenue.

5. Rejection of the Diminishing Revenue Filter and Different Financial Year Filter:
The Tribunal noted that the Hon'ble Delhi High Court in Chryscapital Investment Advisors (India) P. Ltd. Vs. DCIT held that if financial data can be reasonably extrapolated, a company cannot be rejected solely on the ground of a different financial year. The Tribunal found no contrary material to the CIT (Appeals) finding that there was no case of diminishing revenue as alleged by the TPO. Therefore, these grounds of the revenue’s appeal were dismissed.

6. Rejection of M/s Avani Cimcon Technologies Ltd.:
The Tribunal found that the company provided diversified services, including software products, and was not purely a software service provider. The Tribunal would deal with this issue while considering the cross objection of the assessee.

7. Rejection of M/s Kals Information Systems Ltd.:
The Tribunal found that this company was engaged in software products and training services, making it functionally dissimilar to the assessee. This issue would also be dealt with along with other grounds of the cross objection of the assessee.

8. Cross Objections by the Assessee:
The assessee raised several grounds in the cross objection, including the rejection of TP documentation, the use of data at the time of assessment proceedings, and the exclusion of certain companies from the set of comparables. The Tribunal heard the rival submissions and considered the relevant material on record.

9. Exclusion of 12 Companies from the Set of Comparables:
The Tribunal noted that the functional comparability of 11 companies had been considered in the case of Infor (Bangalore) Pvt. Ltd. Vs. ACIT, and Softsol India Limited in M/s. Electronics Imaging India Pvt. Ltd. Vs. DCIT. Following the earlier decisions of the Tribunal, the Tribunal directed the TPO/A.O. to exclude these companies from the set of comparables.

10. Adjustment to the Payment of Interest on External Commercial Borrowings:
The Tribunal found that the assessee did not produce material to show that the interest paid to AE at LIBOR + 3% was arm's length. The Tribunal noted that LIBOR + 1.5% could be taken as arm's length interest, and the TPO's application of LIBOR + 1.38% was within the justified range. Therefore, this ground of the assessee's cross objection was dismissed.

Conclusion:
The revenue’s appeal and the assessee's cross objection were partly allowed. The Tribunal directed the TPO/A.O. to exclude certain companies from the set of comparables and rework the PLI of the comparables, considering the working capital adjustment and proceeding in accordance with the law. The order was pronounced in the open court on 25th Oct., 2017.

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