2019 (12) TMI 1511 - AT - Income Tax

Deduction U/s 10A/10B - proportionate allocation of the head office expenses made by the A.O. while computing the profits of the units eligible for deduction U/s 10A/10B - HELD THAT - As decided in own case 2017 (10) TMI 233 - ITAT MUMBAI assessee is having four units based at various locations which were controlled through its headquarter. The expenditure incurred by head office like travel and conveyance communication expenses legal and professional charges and rates and taxes definitely is having relevance to its total business. Therefore we are of the view that the AO was right in allocating head office expenses to the units eligible for claiming exemption u/s 10A / 10B of the Act. We further observe that there is merit in the argument of the assessee that only net expenses of head office should be allocated to the units claiming exemption u/s 10A / 10B because the assessee is generating other income like interest on fixed deposit and rent which may have some bearing on the functioning of its units claiming exemption u/s 10A / 10B. Therefore we are of the view that the issue needs to be re-examined by the AO in the light of the submissions of the assessee. Hence we set aside the issue to the file of AO and direct him to consider the issue afresh after affording opportunity of hearing to the assessee. TPA - Comparable selection - HELD THAT - Respectfully following the order of the Tribunal in assessee s own case for the A.Y. 2010-11 2019 (10) TMI 1241 - ITAT MUMBAI we do not find any infirmity in the order of the ld. CIT(A) for directing exclusion of companies namely M/s Infosys Ltd. and M/s Larsen Turbo Infotech Limited from the final set of comparables. M/s Zylog Systems Limited the ld CIT(A) has directed for exclusion after recording a finding to the effect that it is a giant in its area of operation and assumes greater risks translating into higher profitability. Thus this giant sized company with advantages such as brand intangibles etc. cannot be compared to a company such as the assessee company which is a captive unit of his AE assuming only limited risks. After recording a similar finding the ld. CIT(A) also excluded Infosys Lt. which is already covered by the order of the Tribunal. The ld DR could not place on record any material so as to persuade us to deviate from the finding of the ld. CIT(A). Functional comparability M/s Thirdware Solutions Ltd. and M/s Kals Information Systems Ltd. with the software development service segment of the assessee - We had carefully perused the order of the Tribunal 2019 (10) TMI 1241 - ITAT MUMBAI and found that exactly on the similar facts and circumstances the Tribunal have confirmed the action of the ld. CIT(A) for exclusion of these companies from the set off final comparables. The ld DR has fairly conceded the fact that the issue is covered by the order of the Tribunal - we do not find any infirmity in the order of the ld. CIT(A) for excluding these comparables. Working capital adjustment while determining the arm s length price of the international transaction in the nature of provision of software development services - HELD THAT - As the facts and circumstances during the year under consideration are pari materia accordingly we direct the A.O. to grant working capital adjustment while determining the ALP for international transaction in terms of direction given by the Tribunal in 2019 (10) TMI 1241 - ITAT MUMBAI

Summary

Issues Involved:
1. Allocation of head office expenses for units claiming exemption under Section 10A/10B of the Income Tax Act.
2. Exclusion of certain companies from the final set of comparables due to large scale of operations.
3. Functional comparability of specific companies with the software development service segment of the assessee.
4. Claim for working capital adjustment while determining the arm's length price of international transactions.

Detailed Analysis:

1. Allocation of Head Office Expenses:
The assessee was aggrieved by the proportionate allocation of head office expenses made by the A.O. while computing the profits of units eligible for deduction under Section 10A/10B. The Tribunal noted that a similar issue was previously restored to the A.O. for fresh adjudication in the assessee's own case for A.Y. 2009-10 and 2010-11. The A.O. had allocated head office expenses based on turnover, arguing that the assessee had parked these expenses in units generating taxable income without valid reasons. The Tribunal observed that head office expenses like travel, communication, legal charges, and taxes are relevant to the total business and should be allocated to units claiming exemption. However, only net expenses should be allocated, considering other income like interest and rent. The Tribunal restored the matter back to the A.O. for fresh adjudication following the same rationale.

2. Exclusion of Certain Companies from Comparables:
The revenue was aggrieved by the CIT(A)'s decision to exclude companies like Infosys Ltd., Larsen & Toubro Infotech Ltd., and Zylog Systems Ltd. from the final set of comparables due to their large scale of operations. The Tribunal upheld the CIT(A)'s decision, noting that these companies were excluded not just due to higher turnover but also due to other parameters such as brand, intangibles, and risk profiles. The Tribunal found no merit in the revenue's argument and dismissed the ground.

3. Functional Comparability of Specific Companies:
The revenue challenged the CIT(A)'s decision not to adjudicate on the functional comparability of Thirdware Solutions Ltd. and Kals Information Systems Ltd. with the assessee's software development service segment. The Tribunal referred to its previous decision for A.Y. 2010-11, where it was held that software development and sale of software products are distinct activities. The Tribunal cited the Hon'ble Jurisdictional High Court's decision, which supported the exclusion of companies engaged in selling software products from the list of comparables. The Tribunal upheld the CIT(A)'s decision to exclude these companies due to functional dissimilarities.

4. Working Capital Adjustment:
The assessee's claim for working capital adjustment while determining the arm's length price was not adjudicated by the CIT(A). The Tribunal referred to its previous order for A.Y. 2010-11, where it directed the A.O. to grant working capital adjustment based on the final set of comparables. The Tribunal found that the assessee had provided the necessary workings for the adjustment and directed the A.O. to grant the working capital adjustment accordingly.

Conclusion:
The Tribunal restored the issue of head office expenses allocation back to the A.O. for fresh adjudication. It upheld the CIT(A)'s decision to exclude certain companies from the comparables due to large scale of operations and functional dissimilarities. The Tribunal also directed the A.O. to grant working capital adjustment while determining the arm's length price. The appeals were disposed of accordingly, with the assessee's appeal allowed for statistical purposes and the revenue's appeal dismissed.