prpri Transfer Pricing : Exclusion of comparable on the basis of High Profit Transfer Pricing : Exclusion of comparable on the basis of High Profit

 CA Ram Bajaj

What is high profit – while determine operating profit for the purpose of TNMM, we have to ascertain the profit earned by enterprise for the basis of comparison. Similarly, we have to ascertain the profit of Compare Company for the purpose of comparison. It is also a part of FAR Analysis. Super profit mean profit more than normal. There is no clear cut definition of super profit. Usually in any type of business whether it is manufacture or service oriented, normal profit is less than 20%. More than normal profit is called super profit in basic accounting terms which is equal applicable in TP study.

Point of Argument – at the time of determination of TP ALP, normally what did TPO.

Example – enterprise is A having profit 18% and studied TP ALP audit, select the company in same business having profit 18-20% and declare that profit at ALP. Then matter goes to TPO, then he reject some comparable adopted by assessee, Add some super profit making companies as comparable and increase the operating profit of comparable, then do TP adjustment.

Now we will discuss super profit marking company inclusion or exclusion in terms of Income Tax Act 1961, OCED guidelines as well as Decision by Tribunal in this regard.

OCED guidelines

“3.65 Generally speaking, a loss-making uncontrolled transaction should trigger further investigation in order to establish whether or not it can be a comparable. Circumstances in which loss-making transactions! enterprises should be excluded from the list of comparables include cases where losses do not reflect normal business conditions, and where the losses incurred by third parties reflect a level of risks that is not comparable to the one assumed by the taxpayer in its controlled transactions. Loss-making corn parables that satisfy the comparability analysis should not however be rejected on the sole basis that they suffer losses.

3.66 A similar investigation should be undertaken for potential corn parables returning abnormally large profits relative to other potential comparables.

The extreme results might consist of losses or unusually high profits itself cannot be a factor for potential comparables; but further examination would be needed to understand the reasons for such extreme results. If some reasons are detected which indicate a defect in the comparability or exceptional conditions for such an extreme results, then only the case may be excluded from the proposed comparables.

Income Tax Rules

The factors for determining inclusion or exclusion of any case in the list of comparables are specifically provided under Rule 10B (2). Therefore, unless and until there are specific reasons and factors as provide under the Rule 10B, an entity cannot be excluded or eliminated from the list of comparables solely on the basis of high profit making unit or loss making unit because no such factor finds place either in Rule 10B(2) or 103 (3) of IT Rule.

Judicial Decision

1. We have carefully considered the submissions. We find that TPO has rejected the assessee’s contention with regard to inclusion of these three supernormal profit companies without any cogent reason. He has not given any comment regarding objection of the assessee regarding inclusion of Crane Software International Limited in the comparables. Regarding Jayamaruthi Software Systems Ltd. he brushed assessee’s objection by simply stating that it is a listed company and results are audited. Regarding assessee’s objection for inclusion of M/s GDA Technologies Ltd. that the said company has sufficient related party transaction, but the TPO has brushed the contention by ignoring the documents submitted by the assessee and holding that data available with him does not show details of related party transaction. It is undisputed that these three companies have shown supernormal comparable profits as compared to the other comparable. There exclusion from the list of comparable is quite correct. Adobe Systems India (P.) Ltd.

2. We have heard the arguments of both the sides and also perused the relevant material on record. It is observed that although a detail submission was made on behalf of the assessee before the ld. CIT(A) on the basis of FAR analysis to show that the selection of M/s Vimta Labs as comparable is not justified, the ld. CIT(A) has not accepted the stand of the assessee on this issue without giving any cogent or convincing reasons. In its recent decision rendered in the case of Adobe Systems India (P.) Ltd. [IT Appeal No. 5043 of 2000, dated 21-01-2011] (Delhi), Delhi Bench of ITAT has held that exclusion of companies showing supernormal profits as compared to other comparable is fully justified. We, therefore, set aside the impugned order of the ld. CIT(A) on this issue and restore the matter to the file of the A.O. with a direction to decide the same afresh after taking into consideration the submissions made by the assessee before the ld. CIT(A) and keeping in view the Delhi Bench of ITA in the case of Adobe Systems India (P.) Ltd. (supra). Teva India (P.) Ltd.

3. There is therefore no bar to considering companies with either abnormal profits or abnormal losses as comparable to the tested party, as long as they are functionally comparable. The OECD guidelines and in US TP regulations, this question may not arise at all because those regulations advocate the quartile method for determining ALP. Indian regulations specifically deviate from OECD guidelines and provide Arithmetic Mean method for determining ALP. In the quartile method, companies that fall in the extreme quartiles get excluded and only those that fall in the middle quartiles are reckoned for comparability. Hence, cases of either abnormal profits or losses (which are referred to as outliners) get automatically excluded. In the arithmetic mean method, all companies that are in the sample are considered, without exception and the average of all the companies are considered as the ALP. Hence, a general rule that companies with abnormal profits should be excluded may be in tune with the principles enunciated in OECD guidelines but cannot be said to be in tune with Indian TP regulations. However, if there are specific reasons for abnormal profits or losses or other general reasons as to why they should not be regarded as comparables, then they can be excluded for comparability. It is for the Assessee to demonstrate existence of abnormal factors. Trilogy E-Business Software India (P.) Ltd.

4. Having heard both the parties and having considered the rival contentions, we find that the only dispute before us is with regard to the comparables adopted by the TPO. The assessee vide its TP study had arrived at four comparable companies, out of which three have been rejected by the TPO as not comparable. Thereafter, the TPO after conducting his own search from the available data base provided arrived at certain other comparables and after calling for assessee’s objections has adopted the final list of comparables. The assessee has accepted some of the comparables adopted by the TPO while it raised objections to the others. The assessee’s objection regarding two companies (1) Asit C Mehta Financial Services Ltd., and (2) Goldstone Infratech Ltd., is on the issue of abnormally higher margin. In our view, this objection is justified on the basis of various decisions of the Tribunal wherein it has been held that super profit making companies have to be excluded from the list of comparable before making transfer pricing adjustment. In the case before us, only these two companies showing profit of more than 100% as compared to the other comparables taken by the TPO. In view of the decisions of the Co-ordinate Benches of the Tribunal, we direct the AO to exclude these two companies from the list of comparables for the purpose of making the transfer pricing adjustment. Google India (P.) Ltd.

5. There is no dispute as regards the comparable namely Valiant Communications Ltd. and X L Telecom and Energy Ltd. at serial no. 1-2 of the above table. The assessee is aggrieved by the action of the TPO in rejecting the PCL and inclusion of Gemini Communication Ltd. The objection against the Gemini Communication Ltd. was raised by the assessee on the ground that the said company is having a super normal profit at 28.07%. We do not agree with the contention of the assessee that the profit at 28.07% is a super normal because the decision relied upon by the assessee in support of its contention are based on the fact where the profit of the comparable as noted by the Tribunal was ranging from 50% to 100% and in those circumstances the Tribunal held that the cases where exceptional profit has been earned and termed as super normal profit should be excluded from the comparables. Therefore, when the profit in case of Gemini Communication does not fall in the category of super normal then merely because of high profits margin cannot be a factor for exclusion from proposed comparables until and unless the extreme results of a case are as a result of exceptional conditions exist Syscom Corporation Ltd

6. (‘xi) Now, coming to the alternative arguments of the assessee that abnormal profit making unit is also to be eliminated on the same analogy on which loss making units are excluded, we, in principle, do not dispute this proposition. The various case laws relied upon by the assessee lay down that a comparable cannot be eliminated just because it is a loss making unit. Similarly, a higher profit making unit cannot also be automatically eliminated just because the comparable company earned higher profits than the average. The reason for rejecting the two loss making units is not just because they were loss making units but for the reasons which are already stated in the preceding paragraphs. If similar reasons existed in the higher profit making unit, then, it is for the assessee to bring out those reasons and seek exclusion of the same. A general argument that, you have to exclude units which have high profit range, in case you exclude units which have made loss is a general submission which cannot be accepted. In other words, as a general principle, both loss making unit and high profit making unit cannot be eliminated from the corn parables unless, there are specific reasons for eliminating the same which is other than the general reason that a comparable has incurred loss or has made abnormal profits. Thus, this ground is dismissed.

7. Thus it is evident that the decisive factors for determining inclusion or exclusion of any case in/from the list of cam parables are the specific characteristics of services provided, assets employed, risks assumed, the contractual terms and conditions prevailing including the geographical location and size of the markets, costs of labour and capital in the markets etc. Nowhere, the higher or lower profit rate, as presumed by the ld. CIT(A). Has been prescribed as the determinative factor to make a case incomparable, rightly so, because profit is not a factor in itself, but consequence of the effect of various factors. Only if the higher or lower profit rate results on account of the effect of factors given in rule 10B (2) read with sub-rule (3), that such case shall merit omission. If however such extreme profit rate is achieved because of factors other than those given in the rule, then such case would continue to find its place in the list of comparables. M/S B P India Services P Ltd,(supra)

8. in the case of Net Linx India P Ltd (supra) and Stream International Services P Ltd (supra) wherein it was held that comparables cannot be deleted on the ground of high margin.’

9. We have heard both the parties and perused the material on record. In our opinion, this issue was considered by the Tribunal in the case of Hellosoft India (P.) Ltd. (supra) wherein it was held that companies having extraordinarily high profit/loss cannot be considered as comparables. Being so, the companies having extraordinarily high profit or loss are to be excluded as comparables. Accordingly, the Assessing Officer is directed to re-calculate the ALP. This ground is partly allowed BA Continuum India (P.) Ltd.

Conclusion – from the above mentioned OCED Guildlines as well as decision of tribunals, we can conclude that there is nothing in Law which probhites the use of abnormal profit company inclusion in comparison, earlier tribunal use to take ground about the exclusion of abnormal profit or abnormal loss making company but now a day’s tribunal use the approach that if assessee establish that the reason of abnormal profit is something else which distinguish the enterprise to compare party, then only the exclusion of super profit company is proper, otherwise these company will also be included in comparison. So now CA as well as Advocate should find some fact as well as reason for the abnormal profit and present that fact to tribunal so for the support of their exclusion. Mere a company is having high profit; it is not a sufficient ground for the exclusion of that company.

(Author can be reached at Mobile- Mobile-09461574223 and email-

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  1. Manish says:

    True, onus should be on Revenue to why including those extereme volume comparables than on assessee to prove the negative

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August 2021