Turnover disparities justify excluding comparables over Rs. 200 crores under Section 92C(2) proviso

The ITAT Bangalore upheld the exclusion of certain comparables based on turnover disparities, affirming that entities with turnover exceeding Rs. 200 crores were rightly excluded when the assessee's turnover was below Rs. 10 crores. Excessive profits or losses alone did not warrant exclusion unless arising from extraordinary events like amalgamation. The tribunal allowed the Revenue's ground regarding the application of the proviso to Section 92C(2) as a standard deduction. Functionally dissimilar companies, particularly those not engaged in software development like the assessee's offshore development centre, were correctly excluded from the comparable list. The Revenue's appeal was dismissed in part and allowed in part consistent with these findings.

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Issues Involved:

1. Exclusion of certain comparable companies due to abnormal profits and amalgamation.
2. Application of the turnover filter for excluding comparable companies.
3. Standard deduction under proviso to Section 92C(2) of the Act.
4. Exclusion and inclusion of specific comparables and risk adjustments.

Detailed Analysis:

1. Exclusion of Comparable Companies Due to Abnormal Profits and Amalgamation:

The Revenue challenged the CIT(A)'s decision to exclude Exensys Software Solutions Ltd. as a comparable due to its abnormal profits resulting from an amalgamation. The Tribunal upheld the CIT(A)'s decision, noting that the exclusion was justified not solely due to high profits but because the profits were a result of an extraordinary event (amalgamation with Holool India Ltd.). The Tribunal emphasized that segmental results were unavailable, further justifying the exclusion.

2. Application of Turnover Filter for Excluding Comparable Companies:

The Revenue contended against the exclusion of Infosys Technologies, iGate Global Solution Ltd., Flextronics Software & Systems Ltd., and L&T Infotech Ltd. based on the turnover filter. The CIT(A) excluded these companies as the assessee's turnover was only Rs. 9.77 crores, and these companies had turnovers exceeding Rs. 200 crores. The Tribunal upheld this decision, citing the principle that companies with significantly higher turnovers are not comparable to those with much lower turnovers. It referenced the Bombay High Court's decision in Pentair Water India (P.) Ltd., which supported the turnover filter.

3. Standard Deduction Under Proviso to Section 92C(2) of the Act:

The Revenue argued that the assessee was not entitled to a standard deduction of 5% under the proviso to Section 92C(2). The assessee conceded this point, and the Tribunal allowed this ground in favor of the Revenue.

4. Exclusion and Inclusion of Specific Comparables and Risk Adjustments:

- Exclusion of Bodhtree Consulting Ltd.: The Tribunal directed the exclusion of Bodhtree Consulting Ltd., referencing a coordinate bench decision in Kodiak Networks India (P.) Ltd., which found that Bodhtree's revenue recognition method led to erratic margins, making it an unsuitable comparable.

- Exclusion of Sankhya Infotech Ltd.: The Tribunal excluded Sankhya Infotech Ltd., noting its involvement in both software products and services without segmental information, making it incomparable.

- Exclusion of Foursoft Ltd.: The Tribunal excluded Foursoft Ltd. due to its high RPT (Related Party Transactions) of 19.89%, exceeding the acceptable threshold of 15%.

- Exclusion of Thirdware Solution Ltd.: The Tribunal excluded Thirdware Solution Ltd., as it was involved in product development without segmental details, making it functionally dissimilar.

- Exclusion of Geometric Software Solutions Co. Ltd.: The Tribunal remanded the issue back to the AO/TPO to examine the functional dissimilarity claim, as it was not previously addressed.

- Exclusion of Tata Elxsi (seg): The Tribunal excluded Tata Elxsi (seg), following the decision in Kodiak Networks India (P.) Ltd., which found it functionally different from the assessee.

- Exclusion of Sathyam Computers Service Ltd.: The Tribunal excluded Sathyam Computers Service Ltd. due to unreliable financial statements, as supported by previous Tribunal and High Court decisions.

Inclusion of New Comparables:

The assessee sought the inclusion of new comparables, which the CIT(A) had not considered. The Tribunal allowed this request, citing the evolving nature of TP (Transfer Pricing) studies, and directed the TPO to consider the new set of comparables. The TPO was also granted the freedom to select fresh comparables, except those specifically directed for exclusion.

Risk Adjustment:

The assessee's plea for risk adjustment due to underutilization of capacity was rejected. The Tribunal agreed with the TPO's findings that the assessee did not bear significant risk compared to the comparables and failed to provide a scientific quantification for the risk adjustment.

Conclusion:

The Tribunal's decision resulted in partial relief for both the Revenue and the assessee, with directions for further analysis and re-evaluation of certain comparables by the TPO. The appeals were treated as partly allowed for statistical purposes.

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