Companies excluded from transfer pricing benchmarking due to functional incomparability and lack of segmental data

ITAT Mumbai held that several companies including Infosys Ltd, Persistent Systems Ltd, Tata Elexi Ltd, and Bodhtree Consulting Ltd should be excluded from transfer pricing benchmarking for software development services due to functional incomparability or lack of segmental data. The tribunal allowed Section 10A deductions for multiple units including UB Plaza and Titanium STPI units, following coordinate bench decisions. The depreciation on goodwill claim was remanded to AO for fresh consideration. Communication and travel expenses exclusion from turnover computation was upheld following SC precedent in HCL Technologies. Software disallowance under Section 40(a)(ia) deletion was sustained following Karnataka HC decision in Tally Solutions.

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1. ISSUES PRESENTED and CONSIDERED

The core legal questions considered in this judgment include:

• Whether the Transfer Pricing Officer (TPO) correctly included or excluded certain companies as comparables for benchmarking the international transaction of "Provision of Software Development Services" and "Provision of ITeS".
• Whether the assessee is entitled to deductions under section 10A of the Income Tax Act for various units, including UB Plaza Unit, Titanium STPI Unit, and the unit acquired from Reuters India Pvt. Ltd.
• Whether the assessee's claim for depreciation on goodwill is allowable under section 32 of the Income Tax Act.
• Whether the Dispute Resolution Panel (DRP) correctly directed the exclusion of communication and travel expenses from both export turnover and total turnover for computing deductions under section 10A.
• Whether the deletion of disallowance on software items under section 40(a)(ia) was justified.

2. ISSUE-WISE DETAILED ANALYSIS

Transfer Pricing Related Issues

The TPO included several companies as comparables for benchmarking the international transaction of "Provision of Software Development Services". The assessee challenged the inclusion of Infosys Ltd., Persistent Systems Ltd., Tata Elexi Ltd. (Segmental), and Bodhtree Consulting Ltd. The Tribunal found these companies to be functionally dissimilar to the assessee, which provides contract software development services, and directed their exclusion based on precedents and the functional profile of the assessee.

Similarly, for "Provision of ITeS", the assessee contested the inclusion of Eclerx Services Ltd., Cosmic Global Ltd., Accentia Technologies Ltd., and Infosys BPO Ltd. The Tribunal found these companies to be functionally different, with some engaged in Knowledge Process Outsourcing (KPO) and others having high brand value and profitability, and thus directed their exclusion.

Deductions under Section 10A

The Tribunal addressed the denial of deductions under section 10A for the UB Plaza Unit, Titanium STPI Unit, and the unit acquired from Reuters India Pvt. Ltd. The Tribunal found that the deduction under section 10A is undertaking-specific and should not be denied merely due to a change in ownership. The Tribunal relied on previous decisions and CBDT Circular No. 1/2013, which clarified that a slump sale does not result in the splitting or reconstruction of an existing business.

Depreciation on Goodwill

The Tribunal considered the assessee's claim for depreciation on goodwill arising from the acquisition of business units. The Tribunal noted that the assessee's claim was based on the Supreme Court's decision in Smifs Securities Ltd., which held that goodwill is an asset under section 32 eligible for depreciation. The Tribunal directed the AO to re-examine the claim in light of the valuation reports and other details provided by the assessee.

Exclusion of Expenses from Turnover

The Tribunal upheld the DRP's direction to exclude communication and travel expenses from both export turnover and total turnover while computing deductions under section 10A. This decision was based on the Supreme Court ruling in HCL Technologies Ltd., which supports such exclusion.

Disallowance on Software Items

The Tribunal upheld the deletion of disallowance on software items under section 40(a)(ia), following the Karnataka High Court's decision in Tally Solutions Pvt. Ltd., which held that depreciation is not an outgoing expenditure and thus not subject to disallowance under section 40(a)(ia).

3. SIGNIFICANT HOLDINGS

The Tribunal established several core principles:

• Transfer pricing comparables must be functionally similar to the tested party, and significant differences in business models, risk profiles, and intangibles justify exclusion.
• Deductions under section 10A are undertaking-specific, and a change in ownership does not negate eligibility if the unit otherwise qualifies.
• Goodwill arising on amalgamation or acquisition can be considered an intangible asset eligible for depreciation under section 32, provided it is properly valued and recorded.
• Expenses excluded from export turnover must also be excluded from total turnover for consistency in computing deductions under section 10A.
• Depreciation is an allowance and not an expenditure subject to disallowance under section 40(a)(ia).

The Tribunal's final determinations included the exclusion of certain companies from the set of comparables for transfer pricing, the allowance of section 10A deductions for specific units, the remand of the depreciation on goodwill issue for further examination, and the upholding of the DRP's directions on turnover exclusions and software disallowance.

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