Decision upholds TNMM, denies ±5% under s.92C(2) due to retrospective s.92C(2A); allows 1% risk adjustment

ITAT (HYD) held that the assessee's selection of comparables under CPM was partly acceptable: companies with turnover > Rs.100 crore were excluded; employee-cost-to-sales and onsite-income filters could not be applied due to unavailable data; loss-making and super-profit companies were excluded. The tribunal denied the assessee's claim to the ±5% proviso under s.92C(2) in view of s.92C(2A)'s retrospective effect. It allowed a 1% risk adjustment to the adjusted average PLI. On method, the tribunal accepted the Revenue's application of TNMM as the most appropriate method and decided that point for the Revenue.

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Issues: (i) Whether the comparables rejected/selected by the TPO by applying various filters (turnover cut-off, employee cost to sales, onsite income and exclusion of loss/super-profit companies) were correctly rejected/accepted; (ii) Whether the proviso to section 92C(2) permitting +/-5% adjustment applies to the assessment years in issue; (iii) Whether a risk adjustment (1%) is allowable in favour of the assessee as directed by the CIT(A); (iv) Whether TNMM is the most appropriate method in place of CPM for determining ALP; (v) Whether transfer pricing adjustments require proof of profit shifting where the assessee's income is exempt under section 10A.

Issue (i): Whether the comparables selected by the TPO using filters (including absence of upper turnover limit, employee cost to sales, onsite income) were appropriate.

Analysis: The decision examines whether differences in scale, data availability and observable financial characteristics materially affect comparability under TNMM; it considers precedents on exclusion of very large entities relative to the assessee, the practical unavailability or non-uniform presentation of employee cost and onsite income data, and the inappropriateness of including loss-making or super-profit entities without adjustment. The Tribunal reviews the filters applied by the TPO and the CIT(A)'s adjustments in selecting a set of comparables and the need to make objective, uniformly applicable exclusions or adjustments.

Conclusion: The filters as applied by the TPO are not wholly sustainable; exclusion of companies with turnover above Rs.100 crores, rejection of employee-cost and onsite-income filters where data is unavailable or non-uniform, and exclusion of loss/super-profit entities are justified; the CIT(A)'s selection of comparables is upheld.

Issue (ii): Whether the benefit of (+)/(-)5% under the proviso to section 92C(2) is available to the assessee for the years in issue.

Analysis: The Tribunal considers the retrospective insertion of section 92C(2A) by the Finance Act, 2012, and its effect that entitlement to the proviso option is barred where the variation exceeds 5% of the arithmetical mean; the Tribunal notes applicable precedents interpreting availability of the +/-5% benefit.

Conclusion: The retrospective amendment in section 92C(2A) precludes granting the standardized (+)/(-)5% benefit; the CIT(A)'s direction to allow the +/-5% standard deduction is modified and disallowed.

Issue (iii): Whether a risk adjustment of 1% should be allowed in favour of the assessee.

Analysis: The Tribunal examines the factual matrix showing the assessee as a captive service provider with limited business risk and references divergent precedents; it assesses whether functional and contractual arrangements justify a risk adjustment.

Conclusion: A risk adjustment of 1% in favour of the assessee is warranted and the CIT(A)'s direction to allow it is upheld.

Issue (iv): Whether TNMM is the most appropriate method in place of CPM for determining ALP.

Analysis: The Tribunal assesses methodological suitability in light of data availability, practical difficulties in identifying and matching gross cost bases under CPM, the similarity between CPM and TNMM in the assessee's facts, prior acceptance of TNMM in earlier years, and judicial guidance that the assessing authority may select a more appropriate method.

Conclusion: TNMM is the most appropriate method for the facts of these assessment years; the challenge to adoption of TNMM is dismissed.

Issue (v): Whether transfer pricing adjustments require proof of profit shifting where the assessee's income is exempt under section 10A.

Analysis: The Tribunal reviews authorities holding that invocation of transfer pricing provisions does not require proof of outward profit shifting and that the statutory condition is the existence of an international transaction requiring computation at arm's length irrespective of exemption status.

Conclusion: The exemption under section 10A does not preclude application of transfer pricing provisions; the assessee's contention is rejected.

Final Conclusion: The net outcome is that the departmental appeal is partly allowed (modification to deny +/-5% benefit; other TPO departures on comparables and adjustments are remitted or upheld as specified), the assessee's cross objections against TNMM and transfer pricing application are dismissed, and the assessee's appeal in the later year is partly allowed for statistical purposes with remand for recomputation consistent with these observations.

Ratio Decidendi: Where data limitations and material functional or scale differences between the tested party and potential comparables exist, comparables must be objectively excluded or adjusted; TNMM may be adopted as the most appropriate method when CPM is impracticable, and a retrospective statutory bar (section 92C(2A)) removes entitlement to the standardized +/-5% proviso where variation exceeds 5% of the arithmetical mean.

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