TPo cannot reject a Comparable for not figuring in his search matrix

Prism Networks Private Limited Vs ACIT (ITAT Bangalore)

The Hon’ble Tribunal held that the DRP has not considered the plea of assessee in proper perspective. The fact that the TPO rejected the TP Study of the Assessee cannot be the basis not to consider the claim of the Assessee for inclusion of comparable companies. The DRP has not adjudicated the question of inclusion of these companies as comparable companies. The fact that these companies do not figure in the search matrix of the TPO is not and cannot be a ground not to consider inclusion of these companies as comparable companies. Since the DRP has failed to do so, the Hon’ble Tribunal directed to AO/TPO for fresh consideration in light of information available in Public Domain.

FULL TEXT OF THE ORDER OF ITAT BANGALORE

This appeal by the Assessee is directed against the order dated 30.03.2021 of National e-Assessment Centre, Delhi (hereinafter referred to as the Assessing Officer, “AO” in short) passed u/s.143(3) read with Section 144C(13) of the Income Tax Act, 1961 (Act) in relation to AY 2016-2017.

2. The Assessee in engaged in the business of provision of Software Development Seryices (SWD services), to its wholly owned holding company. In terms of the provisions of Sec.92-A of the Act, the Assessee and its ‘wholly owned holding company were Associated Enterprises (“AEs”). In terms of Sec.92B(l) of the Act, the transaction of providing SWD Services was an “international transaction” i.e., a transaction between two or more associated enterprises, either or both of whom are non­residents, in the nature of purchase, sale or lease of tangible or intangible property, or provision of services, or lending or borrowing money, or any other transaction having a bearing on the profits, income, losses or assets of such enterprises, and shall include a mutual agreement or arrangement between two or more associated enterprises for the allocation or apportionment of, or any contribution to, any cost or expense incurred or to be incurred in connection with a benefit, service or facility provided or to be provided to any one or more of such enterprises. In terms of Sec.92(1) of the Act, the any income arising from an international transaction shall be computed having regard to the arm’s length price. In this appeal by the Assessee, the dispute is with regard to determination of Arms’ Length Price (ALP) in respect of the international transaction of rendering SWD services to the AE.

3. As far as the provision of Software Development services are concerned, the Assessee filed a Transfer Pricing Study (TP Study) to justify the price paid in the international Transaction as at ALP by adopting the Transaction Net Margin Method (TNMM) as the Most Appropriate Method (MAM) of determining ALP. The Assessee selected Operating Profit/Operating Cost (OP/OC) as the Profit Level Indicator (PLI) for the purpose of comparison of the Assessee’s profit margin with that of the comparable companies. The OP/OC of the Assessee was arrived at 12.69% by the Assessee in its TP study. The operating income was Rs.8,13,02,520/- and the Operating Cost was Rs.7,21,45,894/-. The Operating profit operating income — Operating cost was Rs.91,56,262/-. Thus the OP/TC wed at 12.69%. The Assessee chose companies who are engaged in providing similar services such as the Assessee. The Assessee identified 7 companies whose average arithmetic mean of profit margin was comparable with the Operating margin of the Assessee. The Assessee therefore claimed that the price it charged in the international transaction should be considered as at Arm’s Length.

4. The Transfer Pricing Officer (TPO) to whom the determination of ALP was referred to by the AO, accepted TNMIVI as the MAM and also used the same PLI for comparison i.e., OP/OC. He also selected comparable companies from database. The TPO accepted some companies chosen by the Assessee as comparable companies. The TPO on his own identified some other companies as comparable with the Assessee company and arrived at a set of 13 comparable companies. The PLI was reworked by the TPO at 24.83%. The TPO worked out the average arithmetic mean of their profit margins of the 13 comparable companies as follows:

5. The TPO computed the Addition to total income on account of adjustment to ALP as follows:

“22.4. Computation of Arm’s Length Price:

22.4.1 The median of the weighted average Profit Level indicators is taken as the arm’s length margin. Please see Annexure A for details of computation of PLI of the comparables. Based on this, the arm’s length price. of the services rendered by the taxpayer to its AE(s) is computed as under:

22.4.2 The above shortfall of Rs. 2,03,45,142/-is treated as transfer pricing adjustment u/s 92CA in respect ,-of software development segment of the taxpayer’s international transactions.

Thus a sum of Rs.2,03,45,142/- was added to the total income of the Assessee on account of determination of ALP for provision of SWD services by the Assessee to its AE.

6. The Assessee filed objections before the Disputes Resolution Panel (DRP) against the draft assessment order passed by the AO wherein the addition suggested by the TPO as adjustment consequent to determination of ALP was added to the total income of the Assessee by the AO. The DRP gave certain directions. Based on the directions of the DRP, the AO passed the final order of assessment. To the extent the Assessee did not get relief from the DRP, the Assessee has preferred appeal before the Tribunal.

7. The main grievance of the Assessee projected in the concise grounds of appeal filed before the Tribunal which was argued before us was (i) choice of comparable companies by the TPO which was affirmed by the DRP (Ground No.6), which reads as follows. In this ground, the Assessee has prayed for exclusion of some companies by applying the turnover filter; (ii) Inclusion of certain companies set out in Ground No.7.

“6. The U. TPO / Ld. DRP erred in not accepting the assessee’s contention of exclusion of following 10 companies on the grounds of functional dissimilarity, super profit and high turnover or on other filter etc.

i. Rheal Software Pvt. Ltd.

ii. Larsen & Toubro Infbtech Ltd./

iii. Nihilent Ltd /

iv. Inteq Software Pvt. Ltd.

v. Persistent Systems Ltd,

vi. Infobeans Technologies Ltd

vii. Thirdware Sol, on Ltd

viii. Inforsys Ltd.,

ix. Aspire Systems (India) Pvt. Ltd

x. Cybage Software Pvt. Ltd”

8. As far as Ground No. 6 is concerned, the learned Counsel for the Assessee prayed for exclusion of only 7 companies out of the 10 companies set out in Ground No.6. The three companies which the Assessee does not wish to press for exclusion are (i) Rheal Software Pvt. Ltd., Inteq Software Pvt. Ltd., and (iii) Infobeans Technologies Ltd. The relevant provisions of the Act in so far as comparability of international transaction with a transaction of similar nature entered into between unrelated parties, provides as follows:

Determination of arm’s length price under section 92C .

10B . (1) For the purposes of sub-section (2) of section 92C, the arm’s length price in relation to an international transaction [or a specified domestic transaction] shall be determined by any of the following methods, being the most appropriate method, in the following manner, namely :—

(a) to (d)

(e)transactional net margin method, by which,—

(i) the net profit margin realised by the enterprise from an international transaction [or a ,specified domestic transaction] entered into with an associated enterprise is computed in relation to costs incurred or sales effected or assets employed or to be employed by the enterprise or having regard to any other relevant base;

(ii) the net profit margin realised by the enterprise or by an unrelated enterprise from a comparable uncontrolled transaction or a number of such transactions is computed having regard to the same base;

(iii) the net profit margin referred to in sub-clause (ii) arising in comparable uncontrolled transactions is adjusted to take into account the differences, if any, between the international transaction [or the specified domestic transaction] and the comparable uncontrolled transactions, or between the enterprises entering into such transactions, which could materially affect the amount of net profit margin in the open market;

(iv)the net profit margin realised by the enterprise and referred to in sub-clause (i) is established to be the same as the net profit margin referred to in sub-clause (iii);

(v) the net profit margin thus established is then taken into account to arrive at an arm’s length price in relation to the international transaction [or the specified domestic transaction];

(f) …..

(2) For the purposes of sub-rule (1), the comparability of an international transaction [or a specified domestic transaction] with an uncontrolled transaction shall be judged with reference to the following, namely:—

(a) the specific characteristics of the property transferred or services provided in either transaction;

(b) the functions performed, taking into account assets employed or to be employed and the risks assumed, by the respective parties to the transactions;

(c) the contractual terms (whether or not such terms are formal or in writing) of the transactions which lay down explicitly or implicitly how the responsibilities, risks and benefits are to be divided between the respective parties to the transactions;

(d) conditions prevailing in the markets in which the respective parties to the transactions operate, including the geographical location and size of the markets, the laws and Government orders in force, costs of labour and capital in the markets, overall economic development and level of competition and whether the markets are wholesale or retail.

(3) An uncontrolled transaction shall be comparable to an international transaction [or’a specified domestic transaction] if—

(i)    none of the differences, if any, between the transactions being compared, or between the enterprises entering into such transactions are likely to materially affect the price or cost charged or paid in, or the profit arising from, such transactions in the open market; or

(ii) reasonably accurate adjustments can be made to eliminate the material effects of such differences.

9. A reading of Rule 10B(1)(e)(iii) of the Rules read with Sec.92CA of the Act, would clearly shows that the net profit margin arising in comparable uncontrolled transactions has to be adjusted to take into account the differences, if any, between the international transaction and the comparable uncontrolled transactions, which could materially affect the amount of net profit margin in the open market.

10. Chapters I and IIl of the OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations (hereafter the “TPG”) contain extensive guidance on comparability analyses for transfer pricing purposes. Guidance on comparability adjustments is found in paragraphs 3.47-3.54 and in the Annex to Chapter III of the TPG. A revised version of this guidance was approved by the Council of the OECD on 22 July 2010. In paragraph 2 of these guidelines it has been explained as to what is comparability adjustment. The guideline explains that when applying the arm’s length principle, the conditions of a controlled transaction (i.e. a transaction between a taxpayer and an associated enterprise) are generally compared to the conditions of comparable uncontrolled transactions. In this context, to be comparable means that:

• None of the differences (if any) between the situations being compared could materially affect the condition being examined in the methodology (e.g. price or margin), or
• Reasonably accurate adjustments can be made to eliminate the effect of any such differences. These are called “comparability adjustments.

11. As far as comparability of companies listed as (a) to (g) in Grd.No.4 *sed by the Assessee is concerned, the admitted factual position is that the turnover of these companies is more than Rs.200 Crores and the Assessee’s turnover is only Rs. 8,13,02,520/-. The TPO excluded from the list of comparable companies chosen by the Assessee in its TP study companies whose turnover was less than Rs.1 Crore. The contention of the Assessee before the DRP was that while the TPO excluded companies with low turnover, he failed to apply the same yardstick to exclude companies With high turnover compared to the Assessee. The reason for excluding companies with low turnover was that such companies do not reflect the industry trend as their low cost to sales ratio made their results less reliable. The contention of the Assessee was that there would be effect on profitability wherever there is high or low turnover and therefore companies with high turnover should also be excluded from the list of comparable companies. The DRP primarily relied on the decision rendered by the Hon’ble Delhi High Court in the case of Chryscapital Investment Advisors India Pvt. Ltd Vs. DCIT 82 Taxmann.com 167(Del), wherein it was held that high turnover ipso facto does not lead to the conclusion that a company which is otherwise comparable on FAR analysis can be excluded and that the effect of such high turnover on the margin should be seen. The DRP therefore held that a company which is otherwise functionally comparable cannot be excluded only on the basis of high turnover. The Assessee has raised Grd.No,4 before the Tribunal challenging the aforesaid view of the DRP.

12. On the issue of application of turnover filter, we have heard the rival submissions. The parties relied on several decisions rendered on the above issue by the various decisions of the ITAT Bangalore Benches in favour of the Assessee and in favour of the Revenue, respectively. The ITAT Bangalore Bench in the case of Dell International Services India (P) Ltd. Vs. DCIT (2018) 89 Taxmann.com 44 (Bang-Trib) order dated 13.10.2017, took note of the decision of the ITAT Bangalore Bench in the case of Sysarris Software Pvt. Ltd. Vs. DCIT (2016) 67 Taxmann.com 243 (Bangalore-Trib) wherein the Tribunal after noticing the decision of the Hon’ble Delhi High Court in the case of Chryscapital (supra) and the decision to the contrary in the case of CIT Vs. Pentair Water India Pvt. Ltd., Tax Appeal No.18 of 2015 dated 16.9.2015 wherein it was held that high turnover is a ground to exclude a company from the list of comparable companies in determining ALP, held that there were contrary views on the issue and hence the view favourable to the Assessee laid down in the case of Pentair Water (supra) should be adopted. The following were the conclusions of the Tribunal in the case of Dell International (supra):

“41. We have given a very careful consideration to the rival submissions. ITAT Bangalore Bench in the case of Genesis Integrating Systems (India) Pvt. Ltd. v. DCIT, ITA No.1231/Bang/2010, relying on Dun and Bradstreet’s analysis, held grouping of companies having turnover of Rs. 1 crore to Rs.200 crores as comparable with each other was held to be proper. The following relevant observations were brought to our notice:-

“9. Having heard both the parties and having considered the rival contentions and also the judicial precedents on the issue, we find that the TPO himself has rejected the companies which .ire (sic) making losses as comparables. This shows that there is a limit for the lower end for identifying the comparables. In such a situation, we are unable to understand as to why there should not be an upper limit also. What should be upper limit is another factor to be considered. We agree with the contention of the learned counsel for the assessee that the size matters in business. A big company would be in a position to bargain the price and also attract more customers. It would also have a broad base of skilled employees who are able to give better output. A small company may not have these benefits and therefore, the turnover also would come down reducing profit margin. Thus, as held by the various benches of the Tribunal, when companies which arc loss making are excluded from comparables, then the super profit making companies should also be excluded. For the purpose of classification of companies on the basis of net sales or turnover, we find that a reasonable classification has to be made. Dun & Bradstreet & Bradstreet and NASSCOM have given different ranges. Taking the Indian scenario into consideration, we feel that the classification made by Dun & Bradstreet is more suitable and reasonable. In view of the same, we hold that the turnover filter is very important and the companies having a turnover of Rs. I.00 crore to 200 crores have to be taken as a particular range and the assessee being in that range having turnover of 8.15 crores, the companies which also have turnover of 1.00 to 200.00 crores only should be taken into consideration for the purpose of making TP study.”

42. The Assessee’s turnover was around Rs.110 Crores. Therefore the action of the CIT(A) in directing TPO to exclude companies having turnover of more than Rs.200 crores as not comparable with the Assessee was justified. As rightly pointed out by the learned counsel for the Assessee, there are two views expressed by two Hon’ble High Courts of Bombay and Delhi and both are non-jurisdictional High Courts. The view expressed by the Bombay High Court is in favour of the Assessee and therefore following the said view, the action of the CIT(A) excluding companies with turnover of above Rs.200 crores from the list of comparable companies is held to correct and such action does not call for any interference.”

13. The Tribunal in the case of Autodesk India Pvt. Ltd. Vs. DCIT (2018) 96 Taxmanftcom 263 (Banglore-Tribunal), took note of all the conflicting decision on the issue and rendered its decision and in paragraph 17.7. of the decision held as that high turnover is a ground for excluding companies as not Comparable with a company that has low turnover. The following were the relevant observations:

17.7. We have considered the rival submissions. The substantial question of law .(Question No.1 to 3) which was framed by the Hon’ble Delhi High Court in the case of Chryscapital Investment Advisors (India) Pvt.Ltd., (supra) was as to whether comparable can be rejected on the ground that they have exceptionally high profit margins or fluctuation profit margins, as compared to the Assessee in transfer pricing analysis. Therefore as rightly submitted by the learned counsel for the ^–Assessee the observations of the Hon’ble High Court, in so far as it refers to turnover, were in the nature of obiter dictum. Judicial discipline requires that the Tribunal should follow the decision of a non-jurisdiction High Court, even though the said decision is of a non-jurisdictional High Court. We however find that the Hon’ble Bombay High Court in the case of CIT Vs. Pentair Water India Pvt.Ltd. Tax Appeal No.18 of 2015 judgment dated 16.9.2015 has taken the view that turnover is a relevant criterion for choosing companies as comparable companies in determination of ALP in transfer pricing cases. There is no decision of the jurisdictional High Court on this issue. In the circumstances, following the principle that where two views are available on an issue, the view favourable to the Assessee has to be adopted, we respectfully follow the view of the Hon’ble Bombay High Court on the issue. Respectfully following the aforesaid decision, we uphold the order of the DRP excluding 5 companies from the list of comparable companies chosen by the TPO on the basis that the 5 companies turnover was much higher compared to that the Assessee.

17.8. In view of the above conclusion, there may not be any necessity to examine as to whether the decision rendered in the case of Genisys Integrating (supra) by the ITAT Bangalore Bench should continue to be followed. Since arguments were advanced on the correctness of the decisions rendered by the 1TAT Mumbai and Bangalore Benches taking a view contrary to that taken in the case of Genisys Integrating (supra), we proceed to examine the said issue also. On this issue, the first aspect which we notice is that the decision rendered in the case of Genisys Integrating (supra) was the earliest decision rendered on the issue of comparability of companies on the basis of turnover in Transfer Pricing cases. The decision was rendered as early as 5.8.2011. The. decisions rendered by the ITAT Mumbai Benches cited by the learned DR before us in the case of Willis Processing Services (supra) and Capegemini India Pvt.Ltd. (supra) are to be regarded as per incurium as these decisions ignore a binding co-ordinate bench decision. In this regard the decisions referred to by the learned counsel for the Assessee supports the plea of the learned counsel for the Assessee. The decisions rendered in the case of M/S.NTT Data (supra), Societe Generale Global Solutions (supra) and LSI Technologies (supra) were rendered later in point of time. Those decisions follow the ratio laid down in Willis Processing Services (supra) and have to be regarded as per incurium. These three decisions also place reliance on the decision of the Hon’ble Delhi High Court in the case of Chriscapital Investment (supra). We have already held that the decision rendered in the case of Chriscapital Investment (supra) is obiter dicta and that the ratio decidendi laid down by the Hon’ble Bombay High Court in the case of Pentair (supra) which is favourable to the Assessee has to be followed. Therefore, the decisions cited by the learned DR before us cannot be the basis to hold that high turnover is not relevant criteria for deciding on comparability of companies in determination of ALP under the Transfer Pricing regulations under the Act. For the reasons given above, we uphold the order of the CIT(A) on the issue of application of turnover filter and his action in excluding companies by following the ratio laid down in the case of Genisys Integrating (supra).

14. In view of the aforesaid decision, we hold that 7 companies listed in SI.No.(ii), (iii), (v), (vi) to (x) of Grd.No.6 raised by the Assessee whose turnover in the current year is more than Rs.200 Crores should be excluded from the list of comparable companies.

15. Apart from the exclusion of the comparable companies, the Assessee has also pleaded for inclusion of certain companies. The Assessee has raised ground No.7 in this regard which reads as follows:

7. The Ld. TPO / Ld. DRP erred in not accepting the assessee’s contention of inclusion of following 6 companies which were considered by assessee as its comparables in the TP study. The Ld. TPO ought to have considered the availability of data and ought to have selected these companies as Comparable Companies.

i. Sankhva Infotech Ltd.

ii. Evoke Technologies Pvt Ltd

iii. Sasken Communication Technologies Ltd.

iv. Insummation Technologies Pvt Ltd

v. Kireeti Soft Technologies Ltd

vi. Maveric Systems Ltd.”

16. At the time of hearing, learned Counsel for the Assessee submitted that out of 6 comparable companies set out in ground No.7, he would press for adjudication for inclusion of 5 companies except Sasken Communication Technologies Ltd. As far as inclusion of the aforesaid 5 companies are concerned, the Assessee included the aforesaid 5 companies in its TP study as comparable companies. The TPO did not accept them as comparable companies for the reason that the data with reference to these companies was not available in the public domain. In the objections filed before the DRP, the Assessee specifically pointed out that the data relating to these companies are available in the public domain and has also filed the details in the submissions before the DRP and the same was captured as follows:

A3 Comparables filtered by Assessee: Rejected by TPO — whose rejections are objected by Assessee

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17. The DRP, however, after capturing the gist of the submissions made by the Assessee, proceeded to hold that since the TPO documentation has been rejected by the TPO, the Assessee cannot ask for inclusion of companies which were not part of TPO’s search For these reasons, the DRP rejected the plea of the Assessee for inclusion of the aforesaid 5 companies. Aggrieved by the order of the DRP, the Assessee has raised ground No.7 before the Tribunal.

18. We heard the rival submissions. It is clear from the order of the DRP that the DRP has not considered the plea of the Assessee in proper perspective. The fact that the TPO rejected the TP study of the Assessee cannot be the basis not to consider the claim of the Assessee for inclusion of comparable The TPO excluded these companies only on the ground that information related to these companies was not available in the public domain and this fact was shown to be an incorrect assumption by the Assessee in the submissions before the DRP. In such circumstances, it was incumbent on the part of the DRP to have adjudicated the question of inclusion of these companies as comparable companies. The fact that these companies do not figure in the search matrix of the TPO is not and cannot be a ground not to consider inclusion of these companies as comparable companies. Since the DRP has failed to do so, we are of the view that the issue regarding inclusion of the aforesaid companies as comparable companies should be set aside to AO/TPO for fresh consideration in the light of the information available in public domain. Thus ground No.7 is treated as allowed for statistical purposes.

19. The TPO/AO is directed to compute the ALP of the international transaction of rendering of SWD services by the Assessee to AE in the light of the directions given above, after affording Assessee opportunity of being heard.

20. In the result, the appeal by the Assessee is partly allowed.

Pronounced in the open court on the date mentioned on the caption page.