2018 (7) TMI 2376 - HC - Income Tax

Freight, telecommunication and insurance deductions under s.10A allowed from total and export turnover; high-turnover comparables excluded

The Commissioner of Income-Tax, The Deputy Commissioner of Income-Tax Versus M/s. Analog Devices India Pvt. Ltd.

HC held that deductions for freight, telecommunication and insurance under s.10A must be allowed from total turnover as well as export turnover, applying ... Deduction u/s 10A after reducing telecommunication expenses from the total turnover also - HELD THAT:- The issue is covered by the decision of the Hon’ble Supreme Court in the case of HCL Technologies Ltd [2018 (5) TMI 357 - SUPREME COURT] held that when a particular word is not defined by the legislature and an ordinary meaning is to be attributed to it, the said ordinary meaning is to be in conformity with the context in which it is used. Hence, what is excluded from ‘export turnover’ must also be excluded from ‘total turnover’, since one of the components of ‘total turnover’ is export turnover. Any other interpretation would run counter to the legislative intent and would be impermissible. If the deductions on freight, telecommunication and insurance attributable to the delivery of computer software under Section 10A of the IT Act are allowed only in Export Turnover but not from the Total Turnover then, it would give rise to inadvertent, unlawful, meaningless and illogical result which would cause grave injustice to the Respondent which could have never been the intention of the legislature. TP Adjustment - comparable selection - applying an upper limit of Rs.200 crores for the turnover filter and directing the TPO to compute ALP after excluding the comparable companies dealt with its order ? - Comparables whose turnover is above Rs.200 crores should be excluded from the list of comparable companies. The AO is directed to compute the Arithmetic mean by excluding the aforesaid companies from the list of comparable. M/s KALS Information Systems Ltd., M/s Lucid Systems (India) Ltd., and M/s Accel Transmatics Ltd., (Segment) be excluded as functionally dissimilar. M/s Megasoft Ltd. substantial quantum of international trade and transactions depends upon the fair and quick judicial dispensation in such cases. Had it been a case of substantial question of interpretation of provisions of Double Taxation Avoidance Treaties (DTAA), interpretation of provisions of the Income Tax Act or Overriding Effect of the Treaties over the Domestic Legislations or the questions like Treaty Shopping, Base Erosion and Profit Shifting (BEPS), Transfer of Shares in Tax Havens (like in the case of Vodafone etc.), if based on relevant facts, such substantial questions of law could be raised before the High Court under Section 260-A of the Act, the Courts could have embarked upon such exercise of framing and answering such substantial question of law. On the other hand, the appeals of the present tenor as to whether the comparables have been rightly picked up or not, Filters for arriving at the correct list of comparables have been rightly applied or not, do not in our considered opinion, give rise to any substantial question of law. ISSUES PRESENTED AND CONSIDERED 1. Whether an upper turnover filter (Rs.200 crores) is a permissible and necessary criterion in selecting comparable companies for transfer pricing under Rule 10B and s.92C (TNMM) when the TPO applied only a lower limit. 2. Whether specific comparables (Accel Transmatics Ltd., KALS Information Systems Ltd., Lucid Software Ltd., Tata Elxsi Ltd.) should be excluded as functionally dissimilar despite satisfying qualitative and quantitative filters applied by the TPO and assessee-specific FAR analysis. 3. Whether a company that has developed software following a software development process but lacks legal ownership of software products should be treated as engaged in software products business for comparability purposes. 4. Whether enterprise-level financials of a particular company may be accepted as proper uncontrolled comparable after detailed analysis and information obtained under s.133(6). 5. Whether deductions (e.g., telecommunication expenses) excluded from 'export turnover' under the Explanation to s.10A must also be excluded from 'total turnover' for computation of relief under s.10A. 6. Whether expenses required to be reduced from export turnover under the Explanation to s.10B (e.g., data link charges, foreign travel) must also be excluded from total turnover when computing deduction under s.10B. ISSUE-WISE DETAILED ANALYSIS - Issue 1: Upper Turnover Filter (Rs.200 crores) Legal framework: Selection of comparables for determining Arm's Length Price under s.92C and Rule 10B requires comparability having regard to factors in Rule 10B(2) (including functions, assets, risks, contractual terms); TNMM accepted as most appropriate method. Precedent treatment: Tribunal and coordinated Bench decisions (including Genesis Integrating Systems and other ITAT/Bangalore authorities) have accepted a turnover band of Rs.1 crore to Rs.200 crores for comparability and held that an upper limit is necessary to prevent extreme size disparities; Special Bench (Quark Systems) criticized lower-only filter and deemed absence of upper limit unreasonable. Interpretation and reasoning: Size materially affects comparability - economies of scale and market position can alter prices/profits; comparing a small assessee with very large enterprises (e.g., 277x turnover) is improper. Rule 10B(3)'s requirement that differences should not materially affect price or should be reasonably adjustable supports applying both lower and upper turnover filters. Ratio vs. Obiter: Ratio - the Court treated the application of an upper turnover limit as integral to the comparability exercise under Rule 10B and TNMM; reliance on consistent tribunal practice renders the principle binding for present adjudication. Conclusion: Companies with turnover above Rs.200 crores are to be excluded from the comparable set; AO directed to recompute arithmetic mean excluding such companies. The upper turnover filter is permissible and applicable in the facts of this case. ISSUE-WISE DETAILED ANALYSIS - Issues 2 & 3: Exclusion of Specific Comparables and Characterisation as Software Products Businesses Legal framework: Functional comparability requires assessment of functions performed, assets used, and risks assumed (FAR analysis); Rule 10B(2) and judicial practice mandate excluding entities that are functionally dissimilar even if quantitative filters are met. Precedent treatment: ITAT and coordinate Bench decisions (e.g., Triology E-Business, Capgemini, Logica Pvt. Ltd., Ariba Technologies) have excluded KALS, Accel Transmatic and Lucid Software from comparable lists for software development service providers; those authorities found such entities to be product developers or otherwise functionally different. Interpretation and reasoning: A mere presence of software development processes does not equate to the same business model; legal ownership of software products and the nature of revenue streams (product vs. pure services) materially affect profitability metrics. Information obtained under s.133(6) cannot be used to override public-domain annual report disclosures when inconsistent. Where prior tribunal findings show functional dissimilarity, analogous exclusion is warranted. Ratio vs. Obiter: Ratio - exclusion of given entities as comparables is upheld on functional grounds; the principle that functional differences trump mere satisfaction of broad filters is applied as binding in these circumstances. Observations concerning the limits of s.133(6) use are also treated as operative for comparability assessment. Conclusion: The Tribunal correctly excluded KALS Information Systems Ltd., Accel Transmatics Ltd., and Lucid Software Ltd. from the comparable set as functionally different from a pure software development services assessee; comparability assessment must prioritize FAR over mere quantitative filters. ISSUE-WISE DETAILED ANALYSIS - Issue 4: Acceptance of Enterprise-Level Financials of a Comparable (Megasoft Ltd.) Legal framework: Use of enterprise-level financials is permissible where the entity's consolidated/segmental accounts properly reflect comparable operations and satisfy comparability tests; Rule 10B factors govern the assessment. Precedent treatment: Coordinate Bench and tribunal rulings (Triology E-Business and related decisions) have addressed Megasoft's comparability, with detailed factual analysis determining acceptability. Interpretation and reasoning: Where a Tribunal has, after detailed analysis (including information via s.133(6)), found enterprise-level financials to be appropriate for comparability, appellate review under s.260-A is restricted; an appeal does not raise a substantial question of law merely because the Revenue disagrees with factual findings unless findings are ex facie perverse. Ratio vs. Obiter: Ratio - acceptance of Megasoft's enterprise-level financials as comparables stands where Tribunal's factual findings are not perverse; appellate interference is inappropriate under s.260-A absent a substantial legal question. Conclusion: Tribunal's acceptance of enterprise-level financials of Megasoft Ltd. is sustained; no substantial question of law arises from factual comparability determinations supported by the record. ISSUE-WISE DETAILED ANALYSIS - Issues 5 & 6: Deduction of Certain Expenses from Total Turnover when Excluded from Export Turnover under s.10A/10B Explanations Legal framework: Explanation clauses to ss.10A and 10B specify expenses to be reduced from export turnover for computation of designated deductions; statutory text must be given ordinary meaning in context. Precedent treatment: Supreme Court authority (HCL Technologies) and Karnataka High Court decisions (Tata Elxsi) interpret that expenses excluded from export turnover must also be excluded from total turnover where total turnover includes export turnover, to avoid absurd or unworkable results. Interpretation and reasoning: If expenses like telecommunication, freight, insurance (for s.10A) or data link/foreign travel (for s.10B) are excluded from export turnover, excluding them only from export turnover but not from total turnover would produce inconsistent, absurd, and unjust outcomes and render the formula unworkable. Ordinary meaning and legislative intent require parity between components and aggregate to maintain coherence of the formula. Ratio vs. Obiter: Ratio - deductions excluded from export turnover must be allowed to be excluded from total turnover in the same proportion; reliance on the Supreme Court's reasoning is binding as to statutory interpretation. Conclusion: The Tribunal was correct (in line with higher authority) in directing that specified expenses excluded from export turnover under ss.10A/10B explanations be reduced from total turnover as well; issues 5 and 6 are governed by controlling precedent. ADDITIONAL PRINCIPLE - Scope of Section 260-A Review Legal framework & reasoning: Section 260-A permits High Court interference on substantial questions of law, not mere dissatisfaction with Tribunal's factual findings regarding selection of comparables, application of filters, or factual FAR analysis. Precedent treatment: This Court applied its prior decision (Softbrands India) to hold that appeals contesting comparables/filters without substantial legal questions are not maintainable under s.260-A. Ratio vs. Obiter: Ratio - appellate jurisdiction under s.260-A does not extend to re-evaluating Tribunal's factual determinative exercises unless the Tribunal's findings are ex facie perverse or raise a pure question of law. Conclusion: The Revenue's appeal, which essentially contests factual selections of comparables and filter application, does not raise substantial questions of law; the appeal is dismissed. Cross-reference: Issues 1-4 resolved largely on application of factual comparability principles within Rule 10B and established tribunal practice; appellate intervention was denied accordingly.