2012 (4) TMI 263 - AT - Income Tax

Tribunal excludes loss-making companies from comparables for accurate profit margin analysis 'sLengthPrice

Knoah Solutions (P.) Ltd. Versus Income-tax Officer, Ward 2(1), Hyderabad

Knoah Solutions (P.) Ltd. Versus Income-tax Officer, Ward 2(1), Hyderabad - TMI Issues Involved:1. Exclusion of loss-making companies from comparables for determining the average profit margin under the TNMM method.2. Consideration of abnormal expenses and their impact on profit margins.3. Selection of appropriate comparables for benchmarking international transactions.Detailed Analysis:1. Exclusion of Loss-Making Companies:The primary contention of the assessee was that the CIT(A) erred in law and on facts by excluding loss-making companies from the comparables for determining the average profit margin under the Transactional Net Margin Method (TNMM). The assessee argued that these companies were part of the comparables admitted by the CIT(A) and not objected to by the department, thus becoming final. The CIT(A) excluded the results of the loss-making companies merely on the ground that they were loss-making, without assigning any reason. The assessee contended that exclusion should be based on lack of comparability, not merely on the fact of being loss-making.2. Abnormal Expenses and Their Impact on Profit Margins:The CIT(A) observed that the financial results of M/s Allsec Technologies Limited were affected by abnormal expenses such as connectivity cost and database cost, which together amounted to more than 60% of the revenue. These unusual items distorted the margins, making the data unreliable for comparability analysis. The TPO made a cost analysis of the company during the previous two years and the next two years, indicating that the extra expenses were not pertaining to the transactions of the year, leading to the company's losses. The CIT(A) concluded that these extra items could not be treated as regular operating expenses of the transactions made during the year.3. Selection of Appropriate Comparables:The CIT(A) rejected several comparables on the grounds of lack of comparability. For instance, Genesys International Corporation Limited, Kirloskar Computer Services Limited, and Pentasoft Technologies Limited were excluded because they predominantly functioned differently from the assessee company. The CIT(A) considered only those companies that were functionally similar to the assessee for determining the average Profit Level Indicator (PLI). The CIT(A) also granted a 2% working capital adjustment and a deduction under section 92C(2) at +/-5%, relying on the decision of ITAT, Kolkata in the case of Development Consultants (P) Ltd. v. Dy. CIT.Judgment:The Tribunal upheld the CIT(A)'s decision, emphasizing that the determination of Arm's Length Price (ALP) depends on the facts of each case. The Tribunal noted that the selection of comparables should be based on functional, asset, and risk analysis of both the parties and the transactions. The Tribunal agreed with the CIT(A) that the data of companies like M/s Allsec Technologies Limited and Progeon Limited were not comparable due to abnormal expenses and other factors affecting their profitability. The Tribunal also dismissed the assessee's argument for including loss-making companies as comparables, citing the need for reasonable accurate adjustments to eliminate material effects of differences between transactions.Conclusion:The appeal filed by the assessee was dismissed, with the Tribunal affirming the CIT(A)'s approach in excluding certain comparables and considering only those companies that were functionally similar for determining the average PLI. The Tribunal emphasized the importance of accurate adjustments and comparability in determining the ALP.