2015 (1) TMI 466 - AT - Income Tax

Tribunal directs AO to recompute arm's length price, consider assessee's fresh search

The Tribunal allowed the appeal, directing the AO to re-compute the arm's length price by excluding certain comparables and considering the assessee's ... Transfer pricing adjustment - Arm's Length Price - Transactional Net Margin Method (TNMM) - Profit Level Indicator (OP/OC) - comparability analysis - functional comparability - fresh search / contemporaneous data under Rule 10B(4) - adjustment for differences in risks/assets (Rules 10B(3) read with 10C) - FAR analysis - 5% tolerance band for transfer pricing adjustments - remand for fresh consideration to AO/TPOComparability analysis - functional comparability - Arm's Length Price - 5% tolerance band for transfer pricing adjustments - Exclusion of certain comparables (KALS Information Systems Ltd. (seg) and Bodhtree Consulting Ltd.) from the final list of comparables for the IT services segment and consequent recomputation of ALP. - HELD THAT: - The Tribunal accepted the assessee's contention that KALS Information Systems Ltd. was not functionally comparable, having been found non-comparable in the immediately preceding year and being primarily engaged in sale of software products which is distinguishable from the assessee's captive software services. Bodhtree Consulting Ltd. was excluded because its operating margin showed wide fluctuations (including abnormally high and very low margins) that did not reflect a normal business trend; precedent requires investigation of abnormal margins and exclusion where they do not represent normal business conditions. Having excluded these two comparables, the Tribunal directed the Assessing Officer to recompute the arm's length price applying the average profit margin of the remaining comparables. If the recomputed ALP and the price actually charged fall within the +/-5% band, no transfer pricing adjustment is to be made. The Tribunal therefore allowed the assessee's grounds relating to these comparables for statistical purposes and set aside the adjustment to the extent indicated. [Paras 30, 31, 32, 34, 35]KALS Information Systems Ltd. (seg) and Bodhtree Consulting Ltd. are excluded from the IT comparables; AO to recompute ALP using remaining comparables and, if difference is within +/-5%, no TP adjustment to be made.Comparability analysis - functional comparability - fresh search / contemporaneous data under Rule 10B(4) - FAR analysis - remand for fresh consideration to AO/TPO - Whether certain comparables selected by the TPO in the ITES segment were functionally comparable and whether the TPO improperly rejected comparables proposed by the assessee's fresh search. - HELD THAT: - The Tribunal upheld several of the assessee's objections in ITES: M/s Vishal Information Technologies Ltd. was excluded as functionally dissimilar (outsourcing/intermediary functions and significant vendor payments); Accentia Technologies Ltd. was excluded on account of a different functional profile and extraordinary events (acquisitions) affecting margins; Eclerx Services Ltd. was excluded as providing high-end KPO services unlike the assessee's low-end BPO operations; Cosmic Global Ltd. was also held not functionally comparable. Separately, the Tribunal found that the TPO had rejected a set of comparables identified by the assessee by way of fresh search without conducting a proper FAR-based examination or issuing speaking reasons. That aspect of the comparability analysis was vacated and restored to the file of the AO/TPO for fresh consideration; the AO/TPO is directed to examine those comparables on merits (FAR analysis), give the assessee reasonable opportunity of hearing and decide afresh. [Paras 49, 51, 52, 53, 54]Exclude Vishal Information Technologies Ltd., Accentia Technologies Ltd., Eclerx Services Ltd. and Cosmic Global Ltd. from ITES comparables; remit to AO/TPO the question of comparability of companies proposed in the assessee's fresh search for full FAR-based consideration with opportunity to the assessee to be heard.Final Conclusion: The appeal is allowed for statistical purposes: (i) two IT comparables (KALS and Bodhtree) are excluded and the AO is directed to recompute ALP using the remaining comparables, with no TP adjustment if the recomputed ALP is within +/-5% of the price charged; and (ii) in the ITES segment several listed comparables are excluded and the AO/TPO is directed to re-examine, on FAR analysis and after giving the assessee a hearing, the comparables proposed by the assessee's fresh search. Issues Involved:1. Rejection of benchmarking approach and transfer pricing adjustment.2. Modification of benchmarking analysis and selection of comparables.3. Use of single-year data versus multiple-year data.4. Adjustment for differences in risk levels and assets employed.5. Non-disposal of rectification application by the AO.6. Errors in computing tax demand/liability.Issue-wise Detailed Analysis:1. Rejection of Benchmarking Approach and Transfer Pricing Adjustment:The assessee contested the AO's rejection of their benchmarking approach for international transactions related to IT and ITES services and the subsequent transfer pricing adjustment of Rs. 12,91,06,230. The AO, following the DRP's directions, concluded that the transactions were not at arm's length. The assessee argued that the benchmarking analysis using TNMM and the set of comparables they provided were valid. However, the TPO conducted a fresh search using specific criteria, which led to the rejection of certain comparables initially selected by the assessee.2. Modification of Benchmarking Analysis and Selection of Comparables:The TPO applied additional quantitative and qualitative filters, leading to the inclusion and exclusion of various comparables. The assessee objected to the TPO's selective analysis, arguing that it resulted in cherry-picking comparables, which contradicted scientific search principles. The TPO's criteria included using only current year data (FY 2008-09), selecting companies with more than 50% income from IT services, and excluding companies with less than 75% export earnings, among other filters. The TPO's final set of comparables included companies like FCS Software Solutions Ltd., Akshay Software Technology, KALS Information Systems Ltd., Bodhtree Consulting Ltd., LGS Global Ltd., and Goldstone Technologies Ltd. The assessee objected to the inclusion of KALS Information Systems Ltd. and Bodhtree Consulting Ltd., citing functional dissimilarity and fluctuating profits, respectively. The Tribunal upheld the assessee's objections, excluding these companies from the final set of comparables.3. Use of Single-Year Data Versus Multiple-Year Data:The assessee argued for the use of multiple-year data to benchmark international transactions, while the TPO insisted on using only the current year's data, as mandated by Rule 10B(4) of the IT Rules. The Tribunal noted that the TPO's approach was consistent with the rules but considered the assessee's plea for multiple-year data in specific contexts, such as the inclusion of companies with fluctuating profits.4. Adjustment for Differences in Risk Levels and Assets Employed:The assessee claimed that adjustments for differences in risk levels and assets employed were necessary, as they were a routine captive service provider, unlike the entrepreneurial companies selected as comparables. The TPO and DRP disregarded this argument, but the Tribunal acknowledged the need for such adjustments under Rules 10B(3) and 10C, emphasizing that comparables should reflect similar business conditions.5. Non-disposal of Rectification Application by the AO:The assessee highlighted that the AO did not dispose of their rectification application for correcting mistakes in the transfer pricing order. The Tribunal directed the AO to address this issue in compliance with procedural fairness.6. Errors in Computing Tax Demand/Liability:The assessee pointed out errors in computing the tax demand/liability in the assessment order. The Tribunal instructed the AO to rectify these errors and recompute the tax demand accurately.Conclusion:The Tribunal allowed the appeal for statistical purposes, directing the AO to re-compute the arm's length price of the transactions by excluding KALS Information Systems Ltd. and Bodhtree Consulting Ltd. from the final set of comparables. The Tribunal also instructed the AO to consider the fresh search conducted by the assessee for the ITES segment and provide a reasonable opportunity for the assessee to present their case. The Tribunal emphasized the need for adjustments reflecting similar business conditions and directed the AO to address the rectification application and errors in computing the tax demand.