2021 (3) TMI 1379 - AT - Income Tax

TP Adjustment - Comparable selection - determination of ALP for provision of SWD services - HELD THAT - Companies functionally dissmilar with that of assessee need to b deselected from list of comparables. As relying on case of M/s.NXP India Ltd. 2020 (5) TMI 86 - ITAT BANGALORE we direct exclusion of the following three companies from the list of comparable companies viz. CG Vak Software Exports Ltd. Larsen Toubro Infotech Ltd. and Persistent Systems Ltd. Also we find that in the decision in the case of NXP India Pvt.Ltd. 2020 (5) TMI 86 - ITAT BANGALORE directed inclusion of the following 2 companies viz. Helios Matheson Information Technology Ltd. and R.Systems International Ltd. Inclusion of R.Systems International Ltd. in the list of comparable companies and remand the question of comparability of the company M/S.Helios Matheson Pvt.Ltd. to the AO/TPO for fresh consideration as directed in the case of NXP India Pvt.Ltd. (supra) after affording Assessee opportunity of being heard. Spry Resources India Pvt. Ltd to be included as relying on case of Synamedia India (P) Ltd. 2020 (5) TMI 211 - ITAT BANGALORE dealt with an identical claim made by the assessee who a SWD service provider such as the assessee and in whose case also the very same 7 comparables chosen in the case of assessee in the appeal was chosen as comparable by the TPO. Inclusion of a company by name Evoke Technologies Ltd. - Reasons given by the DRP for not considering this company as a comparable company was due to inconsistency in export turnover for different AYs and incurring of consultancy charges which was alien in the business of SWD services. In this regard the learned Counsel for the assessee has drawn our attention to a decision of the ITAT Delhi Bench in the case of DCIT Vs. Sumi Motherson Innovative Engineering Ltd. 2014 (2) TMI 652 - ITAT DELHI Tribunal took the view that while applying TNMM it is not allowed to compare each and every item of operating cost incurred by assessee with similar cost in case of comparables to ask for adjustment rather it is overall effect of all such individual items culminating into operating profit which is considered for benchmarking assessee s international transaction. We are of the view that Evoke Technologies Pvt. Ltd. which is admittedly rendering SWD services should be regarded as a comparable company and the reasons given for not including the comparable by the DRP cannot be sustained. We direct the inclusion of the aforesaid companies. Nature of expenses - software expenses - revenue or capital expenditure - HELD THAT - We have perused the final Order of Assessment and in para 2 the AO has not followed the directions of the DRP. The DRP had given a specific direction to the AO to examine the invoice and ascertain the nature of expenses and if it is noticed that the expenses are only renewal of licence fees for application software for an year or less then the expenditure has to be allowed as a revenue expenditure. We therefore deem it fit and proper to set aside the order of AO and remand the issue to AO for fresh consideration in accordance with directions of the DRP. We hold and direct accordingly. Disallowance on account of provision for leave encashment - HELD THAT - We are of the view that deduction to the extent of leave encashment as actually been paid should be allowed. We direct the AO to examine the claim of the assessee in this regard and allow deduction on the basis of the actual payment. The other grounds of appeal are purely consequential and does not require any adjudication.

Issues Involved:
1. Determination of Arm's Length Price (ALP) for Software Development Services (SWD).
2. Exclusion and inclusion of specific comparable companies in Transfer Pricing (TP) analysis.
3. Treatment of software expenses as capital or revenue expenditure.
4. Disallowance of provision for leave encashment.

Detailed Analysis:

1. Determination of Arm's Length Price (ALP) for Software Development Services (SWD):
The Assessee, engaged in providing SWD services to its wholly owned holding company (an AE), filed a Transfer Pricing Study (TP Study) using the Transaction Net Margin Method (TNMM) to justify the price paid in the international transaction as at ALP. The Assessee selected Operating Profit/Operating Cost (OP/OC) as the Profit Level Indicator (PLI) and arrived at 19.14%. The Transfer Pricing Officer (TPO) accepted TNMM and OP/TC as the PLI but computed the Assessee's OP/OC at 12.55%. The TPO identified 7 comparable companies with an average arithmetic mean profit margin of 20.90%, leading to an addition of Rs. 86,67,88,686/- to the Assessee's total income.

2. Exclusion and Inclusion of Specific Comparable Companies in Transfer Pricing (TP) Analysis:
The Assessee sought the exclusion of three companies (CG Vak Software & Exports Ltd., Larsen & Toubro Infotech Ltd., and Persistent Systems Ltd.) and the inclusion of four companies (Evoke Technologies Private Ltd., R Systems International Ltd., Spry Resources India Private Limited, and Helios & Matheson Technology Ltd.). The Tribunal, referencing previous decisions, directed the exclusion of CG Vak Software & Exports Ltd., Larsen & Toubro Infotech Ltd., and Persistent Systems Ltd. due to functional dissimilarities and lack of segmental data. The Tribunal included R Systems International Ltd. and remanded the inclusion of Helios & Matheson Technology Ltd. and Spry Resources India Pvt. Ltd. to the TPO for fresh consideration. Evoke Technologies Pvt. Ltd. was directed to be included as a comparable company.

3. Treatment of Software Expenses as Capital or Revenue Expenditure:
The AO treated software expenses of Rs. 1,98,26,333/- as capital expenditure. The DRP directed the AO to examine the invoices to ascertain the nature of the expenses. If the expenses were for renewal of license fees for application software for a year or less, they should be allowed as revenue expenditure. The Tribunal noted that the AO did not follow the DRP's direction and remanded the issue to the AO for fresh consideration.

4. Disallowance of Provision for Leave Encashment:
The Assessee's claim for a deduction of Rs. 3,88,45,034/- on account of provision for leave encashment was disallowed under section 43B(f). The Tribunal directed the AO to allow a deduction to the extent of actual payment of leave encashment during the relevant previous year.

Conclusion:
The Tribunal partially allowed the Assessee's appeal, directing the exclusion and inclusion of specific comparable companies, remanding the treatment of software expenses and the provision for leave encashment to the AO for fresh consideration, and ensuring adherence to the DRP's directions.

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