Chandigarh Tribunal (Special Bench) ruling in the case of DCIT Vs. M/s Quark Systems Pvt. Ltd. (ITA No. 100/Chd/2009) and M/s Quark Systems Pvt. Ltd. Vs. ITO, Ward 5(4) (ITA No. 115/Chd/2009) re-states the ‘importance’ of FAR analysis and provides useful guidance on some of the basic parameters which needs to be considered for selecting ‘appropriate’ com parables.
Facts of the Case
-it is a continuous loss-making company;
– its turnover [INR 1.45 crores] is not comparable to that of Quark’s turnover [INR 13.6 crores]; and
-it is a start-up company having negative net worth as on March 31, 2004.
Accordingly, TPO made an upward adjustment to Quark’s international transaction.
-being a start-up company, it has large setting-up expenses and low turnover;
? Transition and customer contact services provided by Imercius are not comparable to the services provided by Quark; and
-it’s personnel expenses are unusually high [INR 2.17 crores] as compared to its turnover [INR 1.45 crores].
Aggrieved by the decision of the CIT(A), Quark and the department filed cross appeals with the Tribunal against the order of the CIT(A).
Issues, Contentions and the Tribunal’s Ruling & Observations
-The year of operation has no affect on comparability and there are no start-up expenses evident in Imercius financials.
-It had positive net worth at the start of the relevant year which turned negative at the year end due to losses incurred during the year. Further, Imercius’ promoter company had funded it by way of an unsecured loan which may be considered as ‘quasi’ capital.
-Differences in turnover do not impair comparability.
-Screening of com parables on the basis of asset base:
-Incorrect application of turnover filter (i.e. it is open ended).
-Screening based on employee cost to sales ratio.
-On a prima facie basis, Datamatics is not a comparable entity as it has earned extraordinary profit and has a huge turnover in which case it represents an extreme position just like Imercius. Further, there are differences in assets and other characteristics also.
-Further, the Tribunal has relied on various case laws and OECD TP Guidelines 2009 to hold that merely because Quark itself has selected Datamatics as a comparable company; it is not estopped from pointing out a mistake in the assessment. In addition, with a Tribunal being a fact-finding body, it has to take into account all the relevant material and determine the question as per the statutory regulations.
Considering these factors, the Tribunal concluded that since this ground was first raised only before the Tribunal and not before the Tax Authority, the matter be remitted to the AO for consideration. While so remanding, it allowed Quark to submit all the relevant evidence before the AO and fully cooperate in expeditious disposal of the matter in accordance with the law.
Allow ability of +/- 5 per cent benefit?
The Tribunal held that this matter needs to be adjudicated in light of the recent amendment made to the proviso to Section 92(C)(2) Which is effective from October 1, 2009 of the Income-tax Act as the wordings of the amended proviso are significantly different in scope and application vis-à-vis those of the pre-amended proviso. Accordingly, the Tribunal has remanded the matter to the file of the AO for adjudication ‘de novo
The basis of selection of comparable companies and application of filters is inappropriate and open ended.
This Tribunal ruling is once again a step in the right direction, as it refocuses and re-emphasizes on some of the basic fundamentals of TP as summarized below:
Further, with TP being a fact-based exercise, an important decision taken by the Tribunal of allowing the Taxpayer to retract from its earlier position due to additional factual findings at the time of audit proceedings would provide relief to a lot of Taxpayers. However, it is pertinent to note that the Tribunal has simultaneously made an observation that it has taken such a liberal approach on this matter as TP was in its ‘nascent’ stage during the relevant tax year. Therefore, as the TP practice will mature in India such a window of lenient view may not be available to the Taxpayers and hence, it would be imperative to conduct a detailed and a comprehensive analysis.