Tribunal excludes depreciation from ALP costs, upholds purchase price for DSP Software and IP rights.

The tribunal confirmed the exclusion of depreciation from operating costs for Arm's Length Price (ALP) determination. It disagreed with the adjustment proposed by the Transfer Pricing Officer for the purchase of DSP Software and IP rights, directing the Assessing Officer to accept the purchase price as at Arm's Length. The tribunal allowed the assessee's appeal, dismissing the Revenue's appeal.

---

---

Issues Involved:
1. Arm's Length Price (ALP) adjustment for software development services.
2. ALP adjustment for the purchase of DSP Software and IP rights.
3. Exclusion of depreciation from operating costs in ALP determination.

Detailed Analysis:

1. ALP Adjustment for Software Development Services
The assessee, a partnership firm, provided software development services to its Associated Enterprises (AEs). The transactions were benchmarked using the Transactional Net Margin Method (TNMM), showing a Profit Level Indicator (PLI) of 65.09% compared to the average PLI of 29.19% for comparable companies. The Transfer Pricing Officer (TPO) initially recommended an ALP adjustment of Rs. 4,63,99,830/- if the ALP adjustment for DSP Software and IP rights was deleted in any appellate stages. The Dispute Resolution Panel (DRP) directed the exclusion of depreciation costs from operating costs to rework the ALP. After verification, the Assessing Officer (AO) found the taxpayer’s margin to be 73.62%, which was higher than the average margin of comparable companies (29.43%), thus no ALP adjustment was required.

2. ALP Adjustment for Purchase of DSP Software and IP Rights
The major contention was the purchase of DSP Software for Rs. 69,40,25,750/- from Value Labs Sdn, Bhd, Malaysia. The TPO determined the ALP of the DSP software and IP rights as Nil, based on a statement from an executive suggesting the product was developed in India. The DRP partly accepted the assessee’s submissions, noting that the Malaysian entity had taken over the development of the software and had compensated the Indian entity for its services. The DRP concluded that the Indian entity should have been compensated Rs. 12 crores for its R&D work, reducing the ALP for the DSP software to Rs. 50,17,81,250/-. The DRP also rejected the payment of Rs. 7,22,44,500/- for IP rights, as the assessee could not provide reasonable evidence of IP rights transfer.

3. Exclusion of Depreciation from Operating Costs in ALP Determination
The DRP directed the exclusion of depreciation costs from operating costs for both the assessee and comparable companies to provide a level playing field, as the depreciation rates under the Income Tax Act for the assessee (60%) were significantly higher than those under the Companies Act for comparable companies (16.21%). This direction was based on precedents from various ITAT decisions. The tribunal upheld the DRP’s direction, noting that the DRP followed Coordinate Bench decisions and considering the disparity in depreciation costs.

Tribunal's Conclusion:
The tribunal confirmed the DRP's decision to exclude depreciation from operating costs for ALP determination. It disagreed with the DRP's partial confirmation of the TPO’s adjustment for the DSP software and IP rights, noting that the TPO did not analyze the transaction under any prescribed methods and that the DRP’s additional compensation for past services was unwarranted. The tribunal directed the AO to accept the purchase price of the DSP software and IP rights as at Arm's Length, rejecting the Revenue’s grounds and allowing the assessee's appeal.

Final Order:
The assessee’s appeal was allowed, and the Revenue’s appeal was dismissed. The tribunal pronounced the order in the open court on 27th April 2018.

---