Tax appeal excludes improper comparables, applies +/-5% safe-harbour under Section 92C(2), restores assessee's transfer pricing margin

ITAT, PUNE allowed the appeal, holding the Revenue's transfer pricing adjustment excessive and directing exclusion of certain comparables from the benchmarking set. The tribunal found the TPO erred in including companies that breached the assessee's accepted filters (related-party transactions threshold, functional profile and R&D intensity) and ordered exclusion of those comparables, including the product-oriented and functionally non-comparable entities. The tribunal also allowed the assessee the +/-5% safe-harbour under section 92C(2), concluding the declared margin was at arm's length once the improper comparables were removed.

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Issues Involved:
1. Computation of arm's length price (ALP) of international transactions.
2. Use of financial information of comparable companies.
3. Selection and rejection of comparable companies.
4. Application of Related Party Transaction (RPT) criteria.
5. Adjustment for differences in functions, assets, and risks.
6. Application of Proviso to section 92C(2) of the Income-tax Act.
7. Levy of interest under section 234B of the Act.

Detailed Analysis:

1. Computation of Arm's Length Price (ALP) of International Transactions:
The core issue in the appeal was the upward adjustment of Rs 2,45,51,957/- made by the Assessing Officer (AO) in computing the ALP of international transactions. The appellant company benchmarked its international transactions using the Transactional Net Margin Method (TNMM) and identified comparables based on a FAR analysis. The TPO, however, used financial data available at the time of assessment and selected additional comparables, resulting in the disputed adjustment.

2. Use of Financial Information of Comparable Companies:
The appellant argued that the TPO erred in using the financial data of comparable companies for the year ending March 31, 2006, which was not available when the appellant complied with the Indian TP regulations. The Tribunal upheld the TPO's use of data for the financial year 2005-06, as per Rule 10B(4) of the Income-tax Rules, 1962, stating that the appellant did not justify the use of multiple year data.

3. Selection and Rejection of Comparable Companies:
The appellant contended that the TPO unjustly rejected nine out of eleven comparables selected by the appellant and included five new comparables without a sound search strategy. The Tribunal found merit in the appellant's objections regarding certain comparables:
- Compucon Software Ltd.: Excluded due to high RPT exceeding 25%.
- ICSA (India) Ltd.: Excluded due to turnover exceeding Rs 50 crores and high R&D expenses.
- Kals Information System Ltd.: Excluded for being functionally dissimilar, engaged in software product development.

4. Application of Related Party Transaction (RPT) Criteria:
The appellant argued against the TPO's RPT threshold of 25% compared to the appellant's 10%. The Tribunal agreed with the appellant's exclusion of Compucon Software Ltd. due to RPT exceeding 25%, aligning with the TPO's threshold.

5. Adjustment for Differences in Functions, Assets, and Risks:
The appellant claimed that the TPO failed to make adjustments for differences in functions, assets, and risks between the appellant and the comparables. The Tribunal noted that the TPO allowed only a working capital adjustment and did not adequately address the differences in risk profiles.

6. Application of Proviso to Section 92C(2) of the Income-tax Act:
The appellant sought the benefit of the erstwhile Proviso to section 92C(2) for a +/-5% adjustment. The Tribunal allowed this benefit, citing precedents and emphasizing that the amended Proviso effective from 1.10.2009 should not apply retrospectively to the assessment year in question.

7. Levy of Interest under Section 234B of the Act:
The appellant argued against the levy of interest under section 234B for additions based on updated financial data. The Tribunal did not specifically address this issue, as the relief on the main adjustment rendered it moot.

Conclusion:
The Tribunal allowed the appeal, providing relief to the appellant by excluding certain comparables and granting the benefit of the +/-5% adjustment under the erstwhile Proviso to section 92C(2). This resulted in the appellant's margin being at arm's length, thus nullifying the disputed adjustment.

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