In the case of Allscripts (India) Private Ltd.vs. Dy. Commissioner of Income Tax, ITAT Ahemdabad held that for the purpose of find our comparable companies for transfer pricing, companies with very high operating margin can’t be selected as comparable companies without justification/investigation by AO as to why such companies is to be included in the list.
Facts of the case
1. A company is engaged in providing captive software development services to its Associate Enterprise (AE) Eclipsys USA. Assessee electronically filed its return of income for A.Y. 2009-10 on 29.09.2009 declaring total income of Rs. 1,98,18,930/-. Thereafter Assessee revised its return of income on 23.07.2010 declaring total income at Rs. 5,42,868/- by claiming deduction u/s 10AA.
2. Company had rendered software services to its Associated Enterprise (AE), Eclipsys USA, and for which company was remunerated on a cost plus markup basis. For determining arms length nature of the international transactions, company had selected Transactional Net Margin Method (TNMM) as the most appropriate method and had considered operating profit to total cost ratio as the profit level indicator (PLI) in TNMM analysis.
3. The PLI of the company was arrived at 14.58% whereas the average PLI of the 14 comparables that were selected by the company was arrived at 14.45%. Since the price charged in the international transactions by the Assessee was higher than the arithmetical mean price, the price charged in the international transactions by the Assessee was treated as at arms length by the Assessee.
4. Thereafter, during the course of assessment AO has noticed that the Assessee had selected 14 companies as comparables on the basis of search conducted in public data base. The filters/search applied by the Assessee were rejected by TPO and thereafter TPO disregarded the use of multiple year data for testing the markup for services rendered by Assessee, rejected certain quantitative filters applied by the Assessee and introduced certain new quantitative filter, included certain additional comparables which were not considered by the Assessee. Accordingly order u/s. 92CA(3) dated 18.01.2013 was made by TPO by making an upward adjustment in Arms Length Price (ALP) and by virtue of which an amount of Rs. 11,09,37,862/- was added to the total income of the Assessee.
5. Thereafter, a draft order was passed u/s. 143(3) r.w.s. 144C(1) r.w.s. 92CA(3) by making transfer pricing adjustment of Rs. 11,09,37,862/- against which Assessee preferred the reference before Dispute Resolution Panel (DRP). Hon’ble DRP passed order u/s. 144C(5) r.w.s. 144C(8) on 26.12.2013 wherein the TPO was directed to verify the facts and also include some companies as comparables. Pursuant to the directions of DRP, A.O on 05.02.2014 after giving effect to DRP’s direction revised the adjustment at Rs. 4,12,15,474/- and accordingly vide order dated 13.02.2014 that was passed u/s. 143(3) r.w.s. 144C(5) r.w.s. 144C(8) r.w.s. 144C(13) r.w.s. 92CA(3) of the Act the total income of the Assessee was determined at Rs. 4,17,58,342/-.
6. Aggrieved by the aforesaid order of A.O, Assessee is now in appeal before ITAT.
Whether on fact and in law AO is justify in making upwards transfer pricing adjustment to the extent of Rs 4,12,15,474/- by selecting two companies as comparable company for transfer pricing that too with a very high operating margin as against assessee selection of 14 comparable companies?
1. TPO had included certain companies which were functionally dissimilar to the Assessee and had also disregarded the risk, adjustment workings submitted by Assessee. He further submitted that the arithmetic mean of the final set of comparables of the margins was worked out at 21.80% by the TPO as against the margin of Assessee of 14.58%. The ld. A.R. further submitted that while working out the arithmetic mean, TPO had included 2 companies as comparables namely Bodhtree Consulting Ltd. (margin of 54.39%) and EInfochip Bangalore Ltd. (94.43%).
2. That the aforesaid two companies which have been included by TPO needs to be excluded as they cannot be considered as comparable companies in the T.P. study. With respect to exclusion of E-Infochip Bangalore Ltd. as comparable, ld. A.R. submitted that it is a company whose activities cannot be compared with that of Assessee as E-Infochip Bangalore Ltd. was primarily engaged in software development and I.T enabled services.
3. That the results of Bodhtree Consulting Ltd. cannot also be considered to be as comparable because there was drastic fluctuation in the operating margin with a high of 80.15% and low of -4.46% in a period of 6 years which indicates that there could be certain extraordinary fluctuation in operating margins. He pointed to page 124 of the paper book which had the tabulated results of the company from F.Y. 05-06 to F.Y. 10-11. He submitted that the Hon’ble Bangalore Tribunal also in the case of Mindtech India Ltd. vs. DCIT (IT(TP)A No. 70/Bangalore/2014 order dated 21.08.2014) at para 16 of the order had excluded Bodhtree Consulting Ltd. from the final list of comparables.
4. That the Hon’ble Pune Tribunal had also in the case of PTC Software (India) Pvt. Ltd vs. DCIT (in ITA No. 336/PN/2014 order dated 31.10.2014) had excluded Bodhtree Consulting Ltd. He therefore submitted that the aforesaid 2 companies namely Bodhtree Consulting Ltd. and E-Infochip Bangalore Ltd which has been included by the TPO for comparable study be excluded as the same cannot be considered to be a comparable with the Assessee.
Tribunal decision / observations
1. We find that Special Bench of Tribunal in the case of Maersk Global Centres India Pvt. Ltd. in ITA No. 7466/Mum/2012 order dated 07.03.2014 had considered a question as to whether companies having abnormal profits should be excluded as a comparable. The Hon’ble Special Bench took the view that it has to be shown that the high profit margin does not reflect the normal business conditions and only in such circumstances high profit margin companies can be excluded. It was further held that in such circumstances it would require further investigation to ascertain the reasons for unusually high profits and in order to establish whether the entities with such high profits can be taken as comparable or not.
“In generality, we are of the view that the answer to this question will depend on the facts and circumstances of each case inasmuch as potential comparable earning abnormally high profit margin should trigger further investigation in order to establish whether it can be taken as comparable or not. Such investigation should be to ascertain as to whether earning of high profit reflects a normal business condition or whether it is the result of some abnormal conditions prevailing in the relevant year. The profit margin earned by such entity in the immediately preceding year/s may also be taken into consideration to find out whether the high profit margin represents the normal business trend. The FAR analysis in such case may be reviewed to ensure that the potential comparable earning high profit satisfies the comparability conditions. If it is found on such investigation that the high margin profit making company does not satisfy the comparability analysis and or the high profit margin earned by it does not reflect the normal business condition, we are of the view that the high profit margin making entity should not be included in the list of comparable for the purpose of determining the arm’s length price of an international transaction. Otherwise, the entity satisfying the comparability analysis with its high profit margin reflecting normal business condition should not be rejected solely on the basis of such abnormal high profit margin.”
2. We find that the Bangalore Bench of Tribunal in the case of Mindtech India Pvt. Ltd. (supra) had excluded Bodhtree Consulting from the final list of comparable by holding as under:
16. We have considered the rival submissions. The Special Bench of the ITAT in the case of Maersk Global Centres had an occasion to deal with the question as to whether high profit margin making companies should be excluded as a comparable. The Special Bench after considering several aspects held in para 88 of its order that the potential comparable companies cannot be excluded merely on the ground that their profit is abnormally high. The Special bench held that in such cases it would require further investigation to ascertain the reasons for unusually high profit and in order to establish whether the entities with such high profits can be taken as comparable or not. In the light of the aforesaid decision of the Special Bench and in view of the admitted position that the assessee follows Fixed Price Project model where revenues from software development is recognized based on software developed and billed to clients, there is a possibility of the expenditure in relation to the revenue being booked in the earlier year. The results of Bodhtree from F.Y. 2003 to 2008 excluding F.Y. 2007 as given by the learned counsel for the assessee were also perused. Perusal of the same shows, that there has been a consistent change in the operating margins. The chart filed by the Assessee in this regard is given as an annexure to this order. It appears to us that the revenue recognition method followed by the assessee is the reason for the drastic variation in the profit margins of this company. In the given circumstances, we are of the view that it would be sale to exclude Bodhtree Consulting from the final list of comparables chosen by the assessee. We hold and direct accordingly.
3. That Bodhtree Consulting Ltd. as a comparable was excluded by the Pune Tribunal in the case of PTC Software (India) Pvt. Ltd (in ITA No. 336/PN/2014 order dated 31.10.2014).
4. Revenue has not brought any contrary binding decision in its support. With respect to E-Infochip Bangalore Ltd., we find that in the annual accounts of the company, with respect to the segment information it is stated that the company is primarily engaged in software development and I.T enabled services which is considered the only reportable business. With respect to E-infochip Ltd. Assessee had raided objection against its inclusion to which TPO in the order had directed to verify the facts and it was held that it cannot be included on the basis of diminishing of Revenues so long it was a not a consistent loss making company.
5. Considering the aforesaid facts, along with the decisions in case Mindtech India Pvt. Ltd. (supra) and PTC Software (India) Pvt. Ltd, we are of the view that the aforesaid two companies needs to be excluded while working out the comparability analysis and therefore uphold the plea of the Assessee in excluding the margins of the aforesaid 2 companies.
6. We therefore deem it fit to restore the issue back to the file of A.O/TPO, who after excluding the aforesaid 2 companies rework the addition as per facts and law.