DRP cannot absolve from its duty without going into merits of contention of assessee while deciding comparability

Brief of the case:

In the case of M/s. Equant Solutions India Pvt. Ltd. Vs. ACIT Delhi Bench of ITAT remanded back the matter and held that DRP has not met the contention of the assessee in respect of inclusion/exclusion of comparable in its order. ITAT also issued certain direction to DRP to keep in mind while considering comparability.

Facts of the case:

• Assessee Company is a subsidiary of EGN BV, Netherlands.
• During AY 2007-08 assessee was primarily engaged in providing services of two segments:

(a) Information Technology enabled Services i.e. ‘ITES’ which includes technical support and other back-office support services.

(b) Contract software development services i.e. CSD for developing software applications for use within Equant Group/ AE.

• For rendering these services, the assessee was remunerated on an arm’s length cost plus basis i.e. it was compensated for all its operating costs, plus a pre-agreed mark-up of 15% thereon.
• The TPO proposed an adjustment of Rs.l,30,44,743 to the income from the CSD segment and an adjustment of Rs. 7,55,13,180/- to the income from the ITES segment.
• The above adjustment made by the TPO to the income of the assessee was upheld by the AO in his draft assessment order.
• AO passed the final assessment order making an adjustment of Rs.88,557,923 to the assessee ‘s returned income.
• There are 26 companies each in the final list of comparable on account of both segments.

Contention of the assessee:

• DRP without providing any detailed directions regarding the comparables, confirmed the aforesaid adjustment proposed by the AO.
• That the objections regarding filters, comparables, etc. had been taken before the DRP. DRP has not addressed the issues and had only passed a cryptic order without discussing the merit of the matter.
• Certain companies are not comparable in terms of functions performed assets employed and risks assumed.
• TPO arbitrary rejected low-profit / loss making companies based on erroneous and inconsistent reasons.
• TPO Included high-profit making companies in the final comparables set for benchmarking a low risk captive unit disregarding judicial pronouncements on the issue relied on by the assessee.
• TPO demonstrated an intention to arrive at a pre-formulated opinion without complete and adequate application of mind with the single minded intention of making an addition to the returned income of the Assessee.
• Reliance was placed on Mentor Graphics (ITA 1114/2008) where it was held that adjustment should be made to margins of comparable companies to account for differences in functions performed and risks assumed between the comparable companies and the Assessee.

Held by DRP:

• The comparables used in both segments have been put through a filtration process to arrive at a set which is broadly comparable with reference to FAR to that of the assessee.
• Mechanical adjustment cannot be made to the margins of the comparables without knowing which risk was taken by the entity concerned and how its profitability was affected.
• Methodology requires robust data, in the absence of which risk adjustment cannot be considered for enhancing comparability

Held by ITAT:

• After going through the order of DRP, it is clear that the assessee’s objections / contentions against the inclusion/exclusion of the comparables has not been dealt by the DRP while exercising the appellate jurisdiction against a quasi-judicial order of the TPO, which exercise is sine qua non for deciding the issue as to whether a comparable is comparable to the FAR of the tested party i.e. assessee.
• DRP cannot absolve from its duty without going into the merits of the contention of the assessee as to whether a comparable company is comparable to it or not as envisaged by the Act and Rules governing the subject.
• Since the DRP has not met the contention of the assessee in respect of inclusion/exclusion of comparable in its order, ITAT deem fit to remand the matter back to the file of DRP for fresh adjudication.
• ITAT issued following directions to DRP to consider comparability of companies:

(a) Companies with extra ordinary circumstances, like those which suffered events like merger/demerger, impacting the financial results could not be treated as comparables;

(b) Companies which are functionally dissimilar cannot be taken as comparables;

(c) Companies acting merely as intermediary having outsourced its activity cannot be considered as comparables;

(d) Companies whose directors were involved in fraud cannot be taken as comparable, as their financials are not reliable.