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Software firm wins transfer pricing case as tax officer's comparable selections rejected
Software firm wins transfer pricing case as tax officer's comparable selections rejected
This case involves LSI Technologies India (P.) Ltd., a wholly-owned subsidiary of a Cayman Islands company, rendering software development services to its associated enterprise (AE). The Income Tax Officer (ITO) made a transfer pricing adjustment, increasing LSI's arm's length price (ALP) for the services rendered to its AE. LSI challenged the ITO's selection of certain companies as comparables for determining the ALP. The Income Tax Appellate Tribunal (ITAT) ruled in favor of LSI, rejecting several of the ITO's chosen comparables and remanding the matter for fresh determination of the ALP.
Case Name:
LSI Technologies India Private Limited Versus Income-tax Officer, Ward 11 (2), Bangalore (ITAT Bangalore)
Key Takeaways:
- The case highlights the importance of selecting appropriate comparables in transfer pricing cases involving software development services.
- The ITAT laid down principles for determining whether a company can be considered a comparable for a software development services provider.
- The ITAT relied on its own past decisions and legal precedents to exclude certain companies from the list of comparables.
Issue:
Whether the companies selected by the Income Tax Officer as comparables for determining the arm's length price of the software development services rendered by LSI Technologies India (P.) Ltd. to its associated enterprise were appropriate.
Facts:
LSI Technologies India (P.) Ltd. is a wholly-owned subsidiary of Velio Communications International Inc., Cayman Islands. It provides software development services to its parent company (associated enterprise or AE) in relation to chip designing activities. For the assessment year 2007-08, the Transfer Pricing Officer (TPO) selected 26 companies as comparables and determined the arithmetic mean margin at 24.44% after adjustments. This resulted in an upward revision of LSI's arm's length price and an addition of Rs. 8,76,50,141 to its total income. LSI challenged the TPO's selection of certain comparables before the Dispute Resolution Panel (DRP) and the Income Tax Appellate Tribunal (ITAT).
Arguments:
LSI Technologies India's Arguments:
- Several companies selected by the TPO were engaged in developing and selling their own software products, which is functionally different from providing software development services.
- Some comparables were outsourcing their work and did not satisfy the 25% employee cost filter.
- Companies like Infosys, Wipro, and Tata Elxsi owned significant intangibles and earned huge revenues from software products, making them incomparable.
- Certain companies were engaged in knowledge process outsourcing (KPO) services, proprietary software products, and research & development activities, which are different from software development services.
Income Tax Department's Arguments:
- The TPO argued that the selected companies were engaged in software development services and satisfied the necessary filters.
- The Department Representative (DR) relied on the TPO's order and argued against excluding certain comparables.
Key Legal Precedents:
- First Advantage Offshore Services (P.) Ltd. v. Dy. CIT_ [IT (TP) No. 1086 (Bang) of 2011]
- Trilogy E-Business Software India (P.) Ltd. v. Dy. CIT_ [2013] 140 ITD 540/29 taxmann.com 310 (Bang - Trib)
- Curam Software International (P.) Ltd. v. ITO_ [2014] 149 ITD 458/[2013] 37 taxmann.com 141 (Bang - Trib.)
- 3DPLM Software Solutions Ltd. v. Dy. CIT_ [2014] 42 taxmann.com 333 (Bang Trib.)
- PTC Software (India) (P.) Ltd._ [IT Appeal No. 1605 (Pune) of 2011, dated 30-4-2013]
- CIT v. Tata Elxsi Ltd._ [2012] 349 ITR 98/204 Taxman 321/17 taxmann.com 100 (Kar)
The ITAT relied on these precedents to exclude certain companies from the list of comparables based on factors such as functional dissimilarity, ownership of intangibles, engagement in software product development, and outsourcing of work.
Judgment:
The ITAT ruled in favor of LSI Technologies India (P.) Ltd. and set aside the transfer pricing adjustment made by the TPO. The ITAT directed the TPO to exclude several companies from the final list of comparables, including Accel Transmatic Limited, Avani Cimcon Technologies Ltd., Celestial Labs Limited, KALS Infosystems Ltd., Ishir Infotech Ltd., Lucid Software Ltd., Megasoft Limited, Infosys Technologies Limited, Tata Elxsi Ltd., Wipro Limited, E-Zest Solutions Ltd., Persistent Systems Ltd., Quintegra Solutions Limited, Thirdware Solutions Ltd., and Helios & Matheson Information Technology Ltd.
The ITAT remanded the matter back to the TPO for fresh determination of the arm's length price after excluding the aforementioned companies from the list of comparables. The ITAT also allowed LSI's alternate prayer regarding the computation of deduction under Section 10A of the Income Tax Act, following the decision of the Karnataka High Court in _CIT v. Tata Elxsi Ltd._
FAQs:
Q1: What was the significance of the ITAT's decision in this case?
A1: The ITAT's decision provided guidance on the selection of appropriate comparables for determining the arm's length price in transfer pricing cases involving software development services. It highlighted the importance of considering factors such as functional dissimilarity, ownership of intangibles, and engagement in software product development when selecting comparables.
Q2: What were the key legal principles established in this case?
A2: The ITAT relied on legal precedents to establish principles for determining whether a company can be considered a comparable for a software development services provider. These principles include excluding companies engaged in developing and selling their own software products, companies outsourcing their work and failing to satisfy the employee cost filter, companies owning significant intangibles and earning substantial revenue from software products, and companies engaged in KPO services, proprietary software products, and research & development activities.
Q3: What was the impact of the ITAT's decision on the parties involved?
A3: The ITAT's decision was in favor of LSI Technologies India (P.) Ltd. The transfer pricing adjustment made by the TPO was set aside, and the matter was remanded back for fresh determination of the arm's length price after excluding the companies identified by the ITAT from the list of comparables. This decision potentially reduced LSI's tax liability for the assessment year 2007-08.
Q4: How did the ITAT apply legal precedents in this case?
A4: The ITAT relied on its own past decisions and legal precedents from other courts to determine the appropriateness of the comparables selected by the TPO. It cited and followed the principles established in cases such as _First Advantage Offshore Services (P.) Ltd. v. Dy. CIT_, _Curam Software International (P.) Ltd. v. ITO_, _3DPLM Software Solutions Ltd. v. Dy. CIT_, _PTC Software (India) (P.) Ltd._, and _CIT v. Tata Elxsi Ltd._ to exclude certain companies from the list of comparables.
Q5: What was the significance of the ITAT's decision regarding the computation of deduction under Section 10A of the Income Tax Act?
A5: The ITAT allowed LSI's alternate prayer regarding the computation of deduction under Section 10A of the Income Tax Act, following the decision of the Karnataka High Court in _CIT v. Tata Elxsi Ltd._ This decision provided clarity on the treatment of certain expenses for the purpose of computing the deduction under Section 10A.
