Franklin Templeton International Services (India) P. Ltd. Vs DCIT CIR 3(1) (ITAT Mumbai)
Functionally dissimilar entities, entrepreneurs, and product developers were invalid comparables for captive IT service providers
Conclusion: Transfer pricing principles dictate that a captive, risk-mitigated service provider could not be benchmarked against full-fledged, risk-bearing entrepreneurs, companies owning substantial intellectual property, or those generating revenue through software products. If a comparable was engaged in multiple verticals (like software products and software services), the lack of clear segmental financial data renders it completely useless for comparability with a pure software service provider. TPO could not mechanically reject comparables for procedural mismatches—such as a different financial year—if accurate financial data could be mathematically derived using quarterly reports. Similarly, “persistent” loss means consecutive losses; a single year of profit breaks the persistence.
Held: Assessee was a captive service provider rendering Information Technology Enabled Services (ITES) and software development/support services to its Associated Enterprises (AEs). For Assessment Years 2009-10 and 2010-11, the TPO rejected certain comparables proposed by assessee on the grounds of them being “persistent loss-making” companies or following a different accounting year. Conversely, TPO included several companies in the final comparability set that operated on outsourcing/sub-contracting models, provided high-end healthcare services, or were full-fledged entrepreneurs owning significant brand value, goodwill, and intellectual property. TPO also included companies engaged in software product development and diversified activities without maintaining reliable segmental data separating software products from software services. One comparable was included despite having only 60.68% export revenue, failing the 75% export revenue filter applied for the year. Separately, AO disallowed the assessee’s claim for repair and maintenance expenses, which consisted of payments to a service provider and year-end incremental provisions. It was held that companies that earned a profit in at least one out of the three relevant years could not be termed “persistent loss-making” and should be included. Furthermore, a comparable could not be rejected solely for having a different financial accounting year if contemporaneous quarterly data was available to extrapolate the margins. Companies operating on an outsourcing/sub-contracting model or providing high-end healthcare services were functionally dissimilar to a routine captive ITES provider and must be excluded. Full-fledged entrepreneurs possessing significant brand value, intellectual property, scale, and intangibles could not be compared to a risk-insulated captive service provider. Companies developing software products, undertaking diversified operations without specific segmental data for software services, or undergoing significant acquisitions/restructuring must be excluded from the comparability analysis. Any company failing the predetermined 75% export revenue filter (e.g., earning only 60.68% from exports) must be excluded. The disallowance of repair and maintenance expenses was remanded back to the AO to properly verify the actual payments, examine TDS applicability as directed by the Dispute Resolution Panel (DRP), and evaluate the evidence backing the year-end provisions according to the law.
