2018 (4) TMI 2020 - AT - Income Tax

Taxpayer in software services: specific comparables removed, one comparability remitted, section 10B lease/internet deduction remitted for fresh review

M/s. SCM Microsystems (India) Pvt. Ltd. Versus The Assistant Commissioner of Income Tax, Company Circle VI (1), Chennai

ITAT held that the taxpayer operates in software development services and excluded specific companies from the comparable list, directing the TPO/AO to ... TP Adjustment - comparable selection - AR primarily challenged inclusion of certain comparables based on functional difference, certain filters, turnovers etc., with reference to assessee’s activities HELD THAT:- Issue involved in that company was in software development services segment and therefore the decisions relied on by the AR is applicable to the facts of this case, as it is also in the software development services. Tribunal after due analysis of each of the above comparables directed “ exclusion of Avani Cimcon Technologies Ltd., Celestial Labs Ltd., E-Zest Solutions Ltd, Flextronics Software Systems Ltd (Seg), Helios & Matheson Information Technology Ltd, Infosys Technologies Ltd, Ishir Infotech Ltd, Kals Information Systems Ltd, Lucid Software Ltd, Persistent Systems Ltd, and Wipro Ltd (seg), from the list of comparables. Comparability of M/s. Tata Elxsi Ltd (seg), is remitted back to the TPO/AO for consideration afresh as per law. We also direct that Megasoft Ltd, shall be considered for inclusion only after segmentation of its results.” We direct that TPO/AO to comply accordingly. Corresponding grounds of appeal are treated as partly allowed. Computing deduction u/s. 10B - AO reduced incurred towards VSNL lease line charges/internet charges from “export turnover” alone and did not reduce from the total turnover - This issue is remitted back to the AO for a fresh examination. The AO after affording adequate opportunity to the assessee shall apply the above decision, if the facts and circumstances are pari materia with the case of Sak Soft Ltd., supra. Corresponding grounds of appeal are treated as allowed for statistical purposes. ISSUES PRESENTED AND CONSIDERED 1. Whether specific companies relied upon by the Transfer Pricing Officer as comparables in applying the Transactional Net Margin Method (TNMM) are functionally comparable and satisfy applicable filters (including related party transaction (RPT) and employee-cost filters) for determination of arm's length price (ALP). 2. Whether VSNL lease line/internet charges should be excluded from 'total turnover' (and therefore allowed in computing deduction under section 10B) or reduced only from 'export turnover' when calculating deduction under section 10B. ISSUE-WISE DETAILED ANALYSIS Issue 1 - Comparability of selected comparables for TNMM and application of filters Legal framework: - Transfer pricing analysis under the TNMM requires selection of comparable uncontrolled enterprises that are functionally comparable to the tested party; applicable quantitative filters (e.g., related party transaction threshold, employee-cost-to-sales threshold) and sector/segmental similarity are to be applied to arrive at a reliable Profit Level Indicator (PLI) for arm's-length determination. Precedent treatment: - The Tribunal relied on a prior decision of the Bangalore Tribunal addressing comparability in the software development services segment, where numerous comparables were excluded on grounds of functional differences, presence of product/own-IP revenues, atypical extraordinary margins, failure of employee-cost filters, absence of segmental data, or outsized related-party sales. Interpretation and reasoning: - The Tribunal examined the nature of the tested party's business (prototype design, development and related support, and software development services) and compared the functions, assets and risks of the selected comparables. - Functional differences justify exclusion: entities whose primary revenues derive from software products, product licenses/subscriptions, clinical research, animation/KPO services, or significant owned intangibles were found functionally dissimilar to an enterprise providing IT/software development services on specifications from affiliates. - Quantitative filters justify exclusion: comparables failing the employee-cost filter (employee cost materially lower than the 25% benchmark) or exhibiting disproportionately high related-party transactions relative to turnover were treated as unreliable for deriving an arm's-length PLI. - Segmental aggregation issues: where comparables operated multiple segments (product and services) without separate segmental P&L disclosure, their aggregated margins could not reliably reflect the service segment comparable to the tested party; such comparables require segmentation before inclusion. Ratio vs. Obiter: - Ratio: The Tribunal's directions to exclude identified comparables (AvaniCimcon, Celestial Labs, E-Zest, Flextronics segment, Helios & Matheson, Infosys, Ishir Infotech, Kals Information Systems, Lucid Software, Persistent Systems, and Wipro segment) on grounds of functional dissimilarity or failure of filters constitute the binding ratio of the decision for the facts before it. - Obiter: Remittance of comparability of a particular multi-segment entity (Tata Elxsi segment) back to TPO/AO for fresh consideration and the direction that Megasoft be considered only after segmentation are procedural directives linked to fact-specific assessment; these operate as part of the order's operative relief but are fact-specific and not a broad rule on segmentation beyond the case context. Conclusions and directions: - The Tribunal directed exclusion of the specified comparables from the TPO's comparable set for TNMM purposes on grounds of functional non-comparability, failure of applicable filters, or absence of segmental information. - The Tribunal remitted the question of comparability of one multi-segment comparable for fresh examination by the TPO/AO in accordance with law, and directed that another comparable be included only after proper segmentation of results. - Corresponding grounds of appeal on transfer pricing comparability were treated as partly allowed; the TPO/AO is directed to comply with these exclusions/segmentation directions when re-computing the arm's-length PLI and any consequential adjustment. Issue 2 - Treatment of VSNL lease line/internet charges for deduction under section 10B Legal framework: - Section 10B provides deduction in respect of profits of undertakings engaged in export of computer software subject to computation norms that require consideration of 'export turnover' and adjustments to total turnover in calculating eligible profits. Precedent treatment: - The Tribunal referred to an earlier Special Bench decision of the Chennai Tribunal which, on its facts, addressed whether lease line/internet charges should be excluded from total turnover for the purpose of computing deduction under the relevant provision. Interpretation and reasoning: - The assessing officer had reduced the lease line/internet charges only from 'export turnover' and not from 'total turnover.' The assessee contended, relying on the Special Bench authority, that the charges should be excluded from total turnover as well. - The DRP did not decide the point specifically; factual parity with the Special Bench decision had not been finally determined by the AO in the present record. Ratio vs. Obiter: - Procedural (and partly substantive) ratio: The Tribunal did not make a final pronouncement on the legal correctness of excluding the lease line charges from total turnover on the present facts; instead, it remitted the matter to the AO to examine whether the facts are pari materia with the Special Bench precedent and to apply that decision if the factual matrix matches. Conclusions and directions: - The Tribunal remitted the issue to the AO for fresh examination. The AO is to afford the assessee an opportunity of being heard and, if the facts and circumstances are pari materia with the Special Bench authority, apply that decision in computing deduction under section 10B. - The corresponding grounds of appeal on the section 10B issue were treated as allowed for statistical purposes, pending factual determination by the AO in accordance with the Tribunal's direction.