Court directs fresh determination of Arm's Length Prices in transfer pricing appeal

The appeal in the case involved transfer pricing additions in international transactions for software development and sales support services. The court allowed the appeal partially, directing a fresh determination of Arm's Length Prices (ALPs) for these transactions. Specific companies were excluded or included as comparables based on functional dissimilarities and business profiles. The court also addressed issues related to risk adjustment, revenue inclusion, and deduction computation under section 10A. The matter was remitted back to the Assessing Officer/Transfer Pricing Officer for further proceedings.

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Issues Involved:
1. Transfer pricing addition in the international transaction of "Software Development services".
2. Inclusion/exclusion of specific companies from the list of comparables.
3. Risk adjustment in transfer pricing.
4. Transfer pricing addition in the international transaction of "Rendering of sales support services".
5. Inclusion of revenue from sales support division in export and total turnover.
6. Computation of deduction u/s.10A by reducing foreign currency expenses from export turnover.

Detailed Analysis:

I. SOFTWARE DEVELOPMENT SERVICES SEGMENT

1. Transfer Pricing Addition:
The primary issue is the transfer pricing addition of Rs. 19,23,02,633/- made by the Assessing Officer (AO) for the international transaction of "Software Development services". The assessee, a wholly owned subsidiary of BMC, USA, applied the Transactional Net Margin Method (TNMM) with a Profit Level Indicator (PLI) of Operating profits to Total cost (OP/TC). The Transfer Pricing Officer (TPO) made adjustments to the list of comparables, resulting in a transfer pricing adjustment initially computed at Rs. 25,32,54,961/-, which was later revised to Rs. 19,23,02,633/- following directions from the Dispute Resolution Panel (DRP).

2. Inclusion/Exclusion of Comparables:
- Bodhtree Consulting Ltd.: Excluded due to functional dissimilarity and a different revenue recognition model leading to fluctuating profit margins. The Hon’ble Gujarat High Court in Pr. CIT Vs. Allscripts (India) Private Ltd. upheld the exclusion of this company.
- e-Infochips Limited: Excluded because it combined revenues from Software Development and IT Enabled Services (ITES), which is not comparable to the assessee's software development services.
- e-Zest Solutions Ltd.: Included as it is a pure software development company without any signs of software product sales.
- Helios & Matheson Information Technology Ltd.: Excluded as it is engaged in both software services and software sales, making it functionally different from the assessee.
- KALS Infosystems Ltd.: Excluded due to its engagement in both software development services and software products, which is different from the assessee's activities.
- Maars Software International Ltd.: Excluded due to its on-site service model, which impacts operating margins differently compared to the assessee's offshore services.

3. Risk Adjustment:
The assessee sought risk adjustment, which was not granted by the TPO or the DRP. The Tribunal restored the matter to the file of AO/TPO for computing the risk adjustment, following the precedent set in the assessee's own case for the A.Y. 2006-07.

II. SALES SUPPORT SERVICES SEGMENT

1. Transfer Pricing Addition:
The assessee declared an international transaction of "Rendering of sales support services" with a transacted value of Rs. 2,47,84,351/-. The TPO recommended a transfer pricing adjustment of Rs. 33,09,723/-, which was later revised to Rs. 14,78,560/- following directions from the DRP.

2. Inclusion/Exclusion of Comparables:
- TSR Darashaw Limited: Excluded due to a change in its business profile, making it incomparable with the assessee's marketing support services. The Tribunal followed the decision in Honeywell Turbo Technologies (India) Pvt. Ltd. Vs. DCIT for the A.Y. 2008-09, which recognized the changed business profile of TSR Darashaw.

III. OTHER ISSUES

1. Inclusion of Revenue from Sales Support Division:
The ground against the inclusion of revenue from the sales support division in export and total turnover was not pressed by the assessee and hence dismissed.

2. Computation of Deduction u/s.10A:
The AO excluded foreign currency expenses from 'export turnover' without corresponding exclusion from 'total turnover'. The Tribunal held that any exclusion from export turnover should also be reduced from total turnover for the purpose of deduction u/s.10A, following the Hon’ble Delhi High Court in CIT Vs. Genpact India.

3. Interest and Penalty:
The ground relating to charging of interest is consequential, and the ground for initiation of penalty u/s.271(1)(c) is premature.

Conclusion:
The appeal is partly allowed with directions for fresh determination of ALPs for the international transactions of software development services and sales support services, and the matter is remitted to the file of AO/TPO for further proceedings.

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