ITAT: Excludes comparables with high turnover; Remits inclusion issue to CIT(A)
In the transfer pricing dispute involving Zyme Solution Pvt. Ltd., the assessee, a captive ITeS provider to its foreign associated enterprise, claimed arm’s length pricing under the Transactional Net Margin Method (TNMM) with a 10% margin. The Transfer Pricing Officer (TPO) proposed a significant adjustment after benchmarking against high-turnover IT companies, including Tech Mahindra, Infosys BPO, Capgemini, and Harton Communications. The Commissioner of Income-tax (Appeals) excluded these comparables relying on previous Tribunal decisions, but without a detailed functional analysis. The Income Tax Appellate Tribunal held that exclusion must be based on factual comparability, considering Functions, Assets, and Risks (FAR). It noted that high-turnover companies could not serve as comparables for a smaller captive service provider. The Tribunal restored certain issues to the CIT(A) for proper examination, directing exclusion of inappropriate comparables and highlighting that arm’s length pricing requires careful functional and factual analysis rather than mechanical reliance on precedent. The case underscores the importance of proper FAR analysis in TNMM-based transfer pricing.
Facts:
- The assessee, Zyme Solution Pvt. Ltd., is a company incorporated in India and is engaged in the business of providing Information Technology Enabled Services (ITeS) to its Associated Enterprise, namely Zyme Solutions Inc., USA. The assessee operates as a captive service provider, rendering data management and allied support services exclusively to its AE. It is remunerated on a cost-plus basis, with a markup of approximately 10%, and assumes minimal business, market, and entrepreneurial risks.
- For the Assessment Year 2013–14, the assessee filed its return of income on 27 November 2013, declaring a total income of Rs.3,90,84,179. The return was selected for scrutiny. During the relevant previous year, the assessee entered into international transactions aggregating to Rs.35,60,90,650 with its AE for provision of ITeS.
- In compliance with the transfer pricing provisions, the assessee prepared and furnished a Transfer Pricing Study Report. The assessee adopted the Transactional Net Margin Method (TNMM) as the most appropriate method and selected Operating Profit to Operating Cost (OP/OC) as the Profit Level Indicator. The assessee computed its own margin at 10.01%, while the average margin of the comparable companies selected by it was computed at 2.73% (without working capital adjustment). On this basis, the assessee claimed that its international transactions were carried out at arm’s length.
- The matter was referred to the Transfer Pricing Officer under section 92CA of the Income-tax Act, 1961. The TPO rejected the assessee’s TP study and undertook a fresh benchmarking analysis. The TPO computed the assessee’s margin at 10.36%, selected nine comparable companies, and determined their average margin at 20.64%. After making an adjustment of 1.41%, the final mean margin of comparables was arrived at 19.23%.
- On the basis of this analysis, the TPO proposed a transfer pricing adjustment of Rs.2,87,20,804. A draft assessment order was passed on 15.11.2016. As the assessee did not file objections before the Dispute Resolution Panel, the final assessment order under section 143(3) read with section 144C(13) was passed on 27.01.2017, determining the total income at Rs.6,78,06,461.
- Aggrieved by the above, the assessee filed an appeal before the Commissioner of Income-tax, Bangalore. The CIT(A), by order dated 26.07.2024, allowed the appeal partly and excluded the following comparables selected by the TPO:
a. Harton Communications Ltd.
b. Capgemini Business (India) Ltd.
c. Tech Mahindra Ltd.
d. Infosys BPO Ltd.
- While excluding these companies, the CIT(A) primarily relied upon earlier decisions of the Bangalore Bench of the Tribunal, notably ISG Novosoft Technologies and GXS India Technology Centre Pvt. Ltd..
- The Revenue, aggrieved by the exclusion of these comparables, preferred an appeal before the Income Tax Appellate Tribunal. The assessee also filed a cross-objection, contending that certain grounds raised by it regarding inclusion and exclusion of comparables were not adjudicated by the CIT(A).
Issues:
The Revenue, being aggrieved by the order of the Commissioner of Income-tax (Appeals), preferred an appeal before the Hon’ble Tribunal on the following grounds:
1. Whether the Ld. CIT(A) was right in fact and in law in removing as comparables M/s Harton Communications Ltd, M/s Capgemini Business (India) Ltd., M/s Tech Mahindra Ltd and M/s Infosys BPO Ltd on functional dissimilarity.
a. Whether the Ld. CIT(A) is right in not appreciating in fact that transfer pricing is not an exact science and no two entities can be exact replicas.
b. Whether the Ld. CIT(A) is right in trying to find out exact replica of the assessee for determining the Arm’s length price based on such replica, even when the law and the international jurisprudence itself recognize that there cannot be an exact comparable to a given situation, especially with TNMM as the most appropriate method.
2. Whether the Ld. CIT(A) was right in law in demanding comparability standards that may itself defeat the purpose of law relating to determination of Arm’s length price under the income tax Act.
3. Whether the Ld. CIT(A) in imposing conditions is beyond the scope of law and business reality by rejecting all closecomparables on one or the other ground, without appreciating that no two companies can ever be same.
4. Whether the Ld. CIT(A) was right in law and in fact in directing the TPO to excluding the comparables on the ground that the company fails RPT filter despite the fact that the company passes RPT filter.
5. In the facts and circumstances of the case, whether the Ld. CIT(A) is correct in holding that, M/ s Tech Mahindra Ltd., & M/ Infosys BPO Ltd., cannot be taken as comparables holding that the size and turnover of the company are deciding factors for treating a company as a comparable relying on the decision of Hon’ble ITAT, Bangalore in the cases of M/ s ISG Novosoft Technologies Ltd. for A. Y. 2013-14 and GXS India Technology Centre Pvt. Ltd. for A. Y. 2013-14.
6. Whether the Ld. CIT(A) is correct in fact and law in disregarding the position of law that there could be difference between the enterprises compared under the TNMM method that are not likely to materially affect the price or cost charged or the profits accruing to such enterprises.
7. Whether the order of the Ld. CIT(A), relying on the decision of Hon’ble ITAT, Bangalore in the cases of M/ s ISG Novosoft Technologies Ltd. for A. Y. 2013-14 and GXS India Technology Centre Pvt. Ltd. for A.Y. 2013-14, in rejecting comparable cases by insistence on strict comparability under TNMM defeats the very purpose of the law relating to determination of ALP under Income Tax Act.”
Observations:
1. The primary grievance of the Revenue was against the action of the Commissioner of Income-tax (Appeals) in excluding certain comparables, namely Harton Communications Ltd., Capgemini Business (India) Ltd., Tech Mahindra Ltd., and Infosys BPO Ltd., on the ground of functional dissimilarity. The Ld. Departmental Representative submitted before the Tribunal that the CIT(A) had excluded the said comparables without assigning any cogent reasons and had merely relied upon decisions of coordinate benches. It was argued that such an approach was erroneous, particularly in the context of transfer pricing where exact functional identity is neither required nor feasible.
On the other hand, the Ld. Authorised Representative of the assessee supported the order of the CIT(A) and submitted that the comparables excluded were, in fact, not functionally comparable and deserved exclusion even otherwise. It was contended that the reliance placed by the CIT(A) on earlier Tribunal decisions was justified and consistent with settled jurisprudence.
After considering the submissions, the Tribunal recorded a clear finding on the approach adopted by the CIT(A). The Tribunal observed:
“When we peruse the order of the ld. CIT(A), we find that there is no justification given about the functional dissimilarity at all between the comparables and functions of the assessee.”
The Tribunal further found that the exclusions were not based on any independent analysis, noting:
“For each of the exclusion, the ld. CIT(A) has mechanically directed its exclusion relying upon some other decisions of the coordinate Bench.”
The Tribunal also expressed disapproval of the fact that even the basic functional profile had not been examined:
“Even the ld. CIT(A) did not care to mention what are the functions of the assessee and what are the functions of those entities in whose cases, decisions have been rendered by the coordinate Benches are comparable at all.”
In view of the above, the Tribunal concluded:
“Therefore we do not approve the order passed by the ld CIT (A) which is not in conformity with the provisions of the law.”
2. The Revenue further submitted that transfer pricing is not an exact science and that no two entities can be exact replicas of each other. It was argued that under the Transactional Net Margin Method, a reasonable degree of tolerance is built into the law and insistence on near-perfect comparability defeats the very purpose of the method.
While the Tribunal did not dispute the general proposition advanced by the Revenue, it emphasised that statutory requirements cannot be diluted. In this context, the Tribunal observed:
“The provisions of the Act and the Rule clearly says that if the comparability analysis, Functions, Assets & Risk (FAR) are required to be seen.”
Thus, the Tribunal made it clear that although exact identity is not required under TNMM, a proper FAR analysis is mandatory, and the absence of such analysis vitiates the appellate order.
3. The Revenue also contended that the CIT(A), by imposing overly strict comparability standards, had defeated the purpose of arm’s length price determination. According to the Revenue, such insistence ignored business realities and the inherent flexibility of TNMM.
The Tribunal, however, held that the problem was not the insistence on comparability standards per se, but the absence of factual analysis supporting such standards. This conclusion again flowed from the Tribunal’s categorical finding:
“Therefore we do not approve the order passed by the ld CIT (A) which is not in conformity with the provisions of the law.”
4. With respect to Harton Communications Ltd., the assessee submitted that the company failed certain filters and was therefore not comparable. The Revenue, however, argued that such facts were not examined by the CIT(A) and that the exclusion was unsupported by findings.
The Tribunal accepted that the factual position regarding this comparable had not been properly examined. It recorded as under:
“With respect to Harton Communications Ltd. the facts are required to be investigated and verified whether it is comparable or not and the ld. CIT(A) has not given any finding on the same,”
Consequently, the Tribunal held that “…therefore, to that extent, we restore the appeal of the ld. AO back to the file of the ld. CIT(A).”
5. The assessee specifically submitted that Tech Mahindra Ltd., Infosys BPO Ltd., and Capgemini Business (India) Ltd. were high-turnover companies and could not be compared with a captive service provider having a turnover of Rs.35.60 crores. Turnover details and annual reports were placed on record in support of this contention.
Upon examining the material available in the paper book, the Tribunal itself recorded the following observations:
“However it has come to our notice that in the paperbook the assessee has submitted the annual report of Tech Mahindra Ltd., Capgemini Business (India) Ltd. and also substantiated the turnover of Infosys BPO Ltd.”
The Tribunal then reached a clear factual conclusion:
“These are high turnover companies which cannot be compared with the assessee company whose turnover is merely Rs.35.60 crores.”
Accordingly, the Tribunal issued a categorical direction:
“As the facts are available before us, we direct the ld. TPO to exclude the above comparable companies for comparability analysis.”
6. The assessee also contended that certain grounds raised before the CIT(A) had not been adjudicated at all. The Tribunal accepted this contention and observed:
“Not giving a finding on the ground of appeal raised by the assessee before the ld. CIT(A), in the absence of adequate information available before us, it deserves to be restored back to the file of the ld. CIT(A).”
7. Accordingly the appeal of the ld. AO and the CO of the assessee are partly allowed.
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