Sec.10A- Communication cost in absence of profit element is to be excluded from total & export turnover

Brief of the case:

In the case of Pegasystems Worldwide India Pvt. Ltd. Vs. ACIT Hyderabad Bench of ITAT directed the AO to reduce communication cost not only from export turnover but also from the total turnover for the purpose of computation of deduction as per Explanation 2 to section 10A. ITAT relied upon the case of ITO Vs. D.E. Block Indian Software Pvt. Ltd., wherein the tribunal considered the issue of adjustments of total turnover for the purpose of computing eligible profits U/s. 10A and held that the communication expenses need to be excluded from the exports as per the clause-IV of Explantion-2 to section 10A. The above observation was supported by Hon’ble Bombay High Court in the case of CIT Vs. Gem Plus Jewellery India Ltd. [233 CTR 248] (Bombay).

Facts of the case:

• Assessee, is wholly owned subsidiary of Pegasystems, USA, an Associated Enterprise (AE), is a software solution provider to business process management software solutions and business rules platform.
• Assessee filed return of income admitting NIL income for the impugned assessment year.
• Assessee has reported some international transactions in its 3CEB report/TP document whixh were referred by AO for determination of ALP u/s 92CA(1).
• Assessee used Transactional Net Margin Method [TNMM] as most appropriate method (MAM) and short listed 21 comparables with arithmetic mean, PLI (OP/OC) was computed at 11.26% Assessee’s PLI on the reported transactions was at 14.03%.
• The transactions relating to reimbursement to AE which are charged at cost were not considered for any analysis and Assessee held the transactions are thus arm’s length.
• TPO arrived at the operational revenue at 29.21 Crores and operating cost at 25.58 Crores and has taken operating profit at Rs. 3,62,49,720/-. Accordingly, he arrived at OP/OC at 14.17% and OP/OR at 12.41%.
• TPO also noticed that company had receivables to an extent of Rs. 21,07,53,864/- and considered that these are not reported in form 3CEB and no bench marking analysis has been done in the TP study.
• TPO rejected Assessee’s TP document and has undertaken an independent analysis and selected 18 comparables by using various filters and arrived at arm’s length margin at 22.69%.
• By adding negative working capital adjustment, the ALP was arrived at by TPO at 25.08% and ALP of international transactions was determined at 32,00,12,725/-, thereby making adjustment of Rs. 2,79,16,567/- u/s. 92C(3) of the Act. In addition, TPO also made adjustment on receivables at Rs. 1,26,40,592/- thereby determining total adjustment at Rs. 4,05,57,159/-.
• On objection, DRP directed to delete the negative working capital adjustment of (-) 2.39% made by TPO.
• DRP also directed AO to recalculate the computation of deduction u/s 10AA.
• Revenue is aggrieved on the relief granted by DRP, whereas Assessee is aggrieved on the TP adjustments made.
• TPO has selected 18 comparables and arrived at the PLI which was reduced to 21.35% after excluding (Infosys Technologies Ltd.,) by DRP. Out of the aforesaid 18 companies one is excluded by DRP, comparability of 10 companies was not disputed by assessee. Against the remaining 7 companies assessee contested the incomparability and after admitting the contentions of the assessee tribunal directed to exclude some of the companies while in case of others issue of comparability was remanded back to the AO for afresh consideration.
• AO computed the margins of comparable companies by considering the following items as non-operating expenses:

a. Bad and doubtful debts;

b. Bank charges; and

c. Un-allocable expenses in segmental financials.

• AO also made addition in connection to communication expenses by reducing communication cost from export turnover and not reducing the same from total turnover. AO invoked explanation 2 to section 10A.

Contentions of the revenue:

• Method of search process adopted by Assessee suffer from defects which resulted in selection of inappropriate comparables and rejection of companies that are appropriate comparables.
• Assessee has not incurred any expenses towards delivery of software outside India and the expenses are for inter office and intra-office communication over the web and for general purposes and the same is not incurred for delivery of services outside India.
• Even assuming but without admitting that internet service charges are incurred for delivery of software, the same is not specifically received from the customer, the same cannot be reduced from export turnover.
• In the alternate it was also submitted that if the cost is reduced from the export turnover, the similar amount is to be excluded from total turnover.

Contention of the assessee:

• Regarding margins of comparable companies it was contended that these are all part of operational expenditure, hence should have been considered while computing the margins of comparable companies.

Held by ITAT:

• After admitting the contentions of the assessee on the question of incomparability of companies the AO is directed to exclude some of the companies while in case of others the issue is remanded back to AO for afresh consideration.
• As question of comparability was remanded back to AO then issue of non-operating expenses was dismissed with an option to assessee to contest as and when required if need arises.
• Since the direction of DRP in connection with addition of communication cost ITAT denied to interfere with the finding of DRO which is in consistent with the judicial principles laid down by the Hon’ble Bombay High Court in the case of CIT Vs. Gem Plus Jewellery India (Supra).