2013 (11) TMI 967 - AT - Income Tax

TPO's Comparable Selection Upheld but Large Firms and Loss-Making Companies Scrutinized Under TNMM Rule

The ITAT Mumbai held that the TPO acted within statutory limits in selecting comparables for transfer pricing adjustments but criticized the inclusion of ... Transfer pricing adjustments - rejection of the comparables documented in the Transfer Pricing (TP) study - determine Arm's Length Mean Margin (ALM) - Selection of five additional companies arbitrarily - levy of interest u/s 234B and 234D - Held that:- The TPO is very much within the statutory limitations in picking up the data for the last three years including that of the current year (AY 2008-09) for TP study. Therefore, AY 2007-2008 falls within that limitation. Therefore, no fault can be found on this - Ld Counsel has not brought any evidence to suggest that data of these companies used for the TP study relates to the AY 2007-2008 and not of the AY 2008-2009 – No evidence was not brought to our notice to demonstrate that the FAR analysis, PLIs etc of these additional 5 comparables considered by the TPO in that case relate to that of the AY 2007-08 - Decided against assessee. Inappropriate filters for screening companies – Turnover filter, employee cost and onsite revenue - Held that:- On the filter relating to providing maximum turnover limit when the minimum turnover limit is proscribed, the comparables Infosys Technologies Ltd and Wipro Ltd are the target companies - The issue is not adjudicated by revenue authorities meaningfully - The TPO should have provided maximum limits too and he should not have pickup up the comparable such as Infosys and Wipro Ltd which are giants with huge turnovers - If these two companies with high turnover and margins are excluded, the assessee PLI is at arm's length and consequently, the TP adjustments are not required – The issue was remanded back for fresh adjudication. Functionally comparable companies – Held that:- The giant companies namely, Infosys Technologies and the Wipro Ltd are not good comparables on the grounds of the nature of services, risk profile, revenues, ownership of intangibles, onsite vs offshore works, expenditure on advertising, sales promotion and R& D developments etc - The onus is on the assessee to demonstrate that the turnover' factor has impact on the operating profits' of the company - The orders of AO/TPO/DRP do not contain reasoning for inclusions of these two comparable - They do not contain any reasoning rejecting the objections raised by the assessee - On the issue of giantness – It is a generic function and the turnover constitutes one of the factors contributing to the giantness - Assessee needs to demonstrate that the turnover factor influences the operating profits of the said comparables – The issue was remanded back for fresh adjudication. Selection of comparable companies – Non consideration – Held that:- Loss making companies should not be deemed as good comparable considering the TNMM method - Loss and super profits are the extremities and the onus is on the assessee to explain the reasons with evidences to substantiate these extreme results in loss and super profits - As per the OECD TP guidelines, the losses or unusual profits/losses constitute extreme results and such results demands further examination into the reasons for such results - If such examination results in detection of the cogent reasons causing such losses there is need for adjustments to the margins or exclusions of that case for the purpose of comparability studies – Following Willis Processing Services (I) (P.) Ltd. Versus Deputy Commissioner of Income-tax 2(3), Mumbai [2013 (3) TMI 415 - ITAT MUMBAI]- Decided against assessee. Operating Margins – Held that:- The TPO considered the interest on the loan as the non-operating one and he considered the related foreign exchange loss on interest on loan as the operating expense – The foreign exchange loss on interest on loan warrants a similar treatment - Decided in favour of assessee. Working capital and risk adjustments – Held that:- The orders of the Revenue do not contain the relevant analysis before rejecting the claim of the assessee in this regard - The order of the DRP and TPO in this regard was non-speaking order – The issue was remanded back for fresh adjudication. Issues Involved:1. Rejection of comparables in the Transfer Pricing (TP) study.2. Addition of certain companies to the comparable set.3. Use of appropriate filters for screening companies.4. Acceptance of functionally non-comparable companies.5. Incorrect computation of the appellant's operating margin.6. Rejection of working capital and risk adjustments.7. Non-consideration of additional companies offered as comparables.8. Levy of interest under sections 234B and 234D.9. Initiation of penalty proceedings under section 271(1)(c).Detailed Analysis:1. Rejection of Comparables in the Transfer Pricing (TP) Study:The appellant did not press ground no.1, which questioned the decision of rejecting the comparables documented in the TP study. Consequently, this ground was dismissed as not pressed.2. Addition of Certain Companies to the Comparable Set:Ground no.4 addressed the TPO's decision to include five additional companies as comparables for AY 2008-2009, based on their consideration for AY 2007-2008. The appellant argued that AY 2008-2009 was the first year of assessment for the appellant, making the inclusion of these comparables inappropriate. However, the Tribunal found that the TPO was within statutory limitations to use data from the last three years, including AY 2007-2008. The Tribunal rejected the appellant's objections due to a lack of evidence showing that the data used pertained to AY 2007-2008 instead of AY 2008-2009. Thus, ground no.4 was dismissed.3. Use of Appropriate Filters for Screening Companies:Ground no.6 revolved around the use of inappropriate filters, such as turnover, employee cost, and onsite revenue, for screening companies. The appellant argued that companies with extremely high turnovers, like Infosys and Wipro, should have been excluded. The Tribunal agreed that the issue of turnover needed further examination and remanded the matter to the AO/TPO/DRP for a fresh decision, directing them to pass a speaking order after considering the appellant's objections. The Tribunal upheld the correctness of the TPO's decision regarding employee cost and onsite revenue filters, dismissing the appellant's objections in this regard. Thus, this ground was partly allowed for statistical purposes.4. Acceptance of Functionally Non-Comparable Companies:Ground no.7 related to the acceptance of certain companies as comparables despite being functionally different. The Tribunal examined each disputed comparable:- Acropetal Technologies Limited (Seg.): The Tribunal upheld the TPO's decision, finding the company functionally comparable.- Avani Cimcon Technologies: The Tribunal found this company functionally different and directed its exclusion.- Bodhtree Consulting Limited: The Tribunal found this company engaged in software products and directed its exclusion.- E-infochip Limited: The Tribunal upheld the TPO's decision, finding the company functionally comparable.- Kals Information System Limited (Seg.): The Tribunal found this company functionally different and directed its exclusion.- Tata Elxsi Limited (Seg.): The Tribunal upheld the TPO's decision, finding the company functionally comparable.- Infosys Technologies & Wipro Limited: The Tribunal remanded the matter to the AO for fresh examination, noting the need for detailed analysis and reasoning.Thus, this ground was partly allowed for statistical purposes.5. Incorrect Computation of the Appellant's Operating Margin:Ground no.10 addressed errors in computing the appellant's operating margin. The Tribunal agreed with the appellant's contention that foreign exchange loss related to interest payments should be considered non-operating in nature. The Tribunal directed the AO to exclude the foreign exchange loss from the operating cost for computing the operating margins. Thus, ground no.10 was allowed.6. Rejection of Working Capital and Risk Adjustments:Ground no.11 dealt with the need for working capital and risk adjustments. The Tribunal found that the orders of the Revenue did not contain relevant analysis for rejecting the appellant's claim. The Tribunal remanded the matter to the AO for fresh adjudication, directing them to consider relevant decisions and pass a speaking order. Thus, this ground was remanded for fresh adjudication.7. Non-Consideration of Additional Companies Offered as Comparables:Ground no.9 related to the non-consideration of additional companies offered by the appellant as comparables. The Tribunal found merit in the appellant's contention and remanded the matter to the DRP/TPO/AO for fresh adjudication, directing them to pass a speaking order. Thus, ground no.9 was allowed for statistical purposes.8. Levy of Interest Under Sections 234B and 234D:Ground no.13 addressed the levy of interest under sections 234B and 234D, which the Tribunal allowed as consequential.9. Initiation of Penalty Proceedings Under Section 271(1)(c):The Tribunal found the issue of initiation of penalty proceedings under section 271(1)(c) to be infructuous and dismissed it.Conclusion:The appeal was partly allowed, with certain grounds remanded for fresh adjudication and others dismissed or allowed based on the Tribunal's detailed analysis. The Tribunal directed the AO/TPO/DRP to pass speaking orders after considering the appellant's objections and relevant legal precedents.