Transfer pricing comparability adjustments: exclusion of comparables for differing financial years and functionality failures; arm's length methods applied.

Decision addresses transfer pricing comparability selection and arm's length determination. A comparable was excluded because it failed the financial year filter and must be removed. Several comparables were found not functionally similar and are directed to be excluded for failing the functionality test. The tribunal upheld application of arm's length margin determination rules given sufficient comparables, rejected the appellant's plea to exclude high-margin companies, and directed the assessing officer/TPO to verify functional similarities of three specified comparables and apply arm's length methods; any found non-functional may be excluded.

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Issues Involved:
1. Assessment and reference to the Transfer Pricing Officer.
2. Validity of the transfer pricing order.
3. Conformity of the assessment order with DRP directions.
4. Fresh comparability/benchmarking analysis.
5. Application of arbitrary filters in selecting comparables.
6. Rejection of comparables selected by the Appellant.
7. Selection/rejection of comparable companies.
8. Adjustment value on software development income.
9. Set-off of brought forward business losses and unabsorbed depreciation.
10. Set-off of MAT credit entitlement.
11. Grant of Foreign Tax Credit.
12. Grant of interest under section 244A.
13. Issuance of refund.
14. Initiation of penalty proceedings.
15. Relief.

Detailed Analysis:

1. Assessment and Reference to the Transfer Pricing Officer:
The appellant challenged the legality of the assessment order dated February 21, 2022, under sections 143(3), 144C(13), and 144B of the Income-tax Act, 1961, arguing that the Deputy Commissioner of Income-tax (DCIT) did not record an opinion that any conditions under section 92C(3) were met. The appellant also contended that the Transfer Pricing Officer (TPO) did not provide a hearing opportunity before rejecting the arm's length price computed in the appellant's Transfer Pricing Study. Additionally, the appellant argued that the TPO did not demonstrate a motive to shift profits outside India, which is a prerequisite for adjustments under Chapter X of the Act.

2. Validity of the Transfer Pricing Order:
The appellant contended that the transfer pricing order dated January 22, 2021, should be struck down as it was not conducted in a faceless manner as required by CBDT Notifications. The Dispute Resolution Panel (DRP) upheld the transfer pricing assessment, which the appellant argued was erroneous.

3. Conformity of the Assessment Order with DRP Directions:
The appellant argued that the final assessment order dated February 21, 2022, was invalid as it did not conform to the DRP's directions under section 144C(13). Specifically, the TPO was directed to exclude certain margins after verifying specific filters, which the appellant claimed were not followed.

4. Fresh Comparability/Benchmarking Analysis:
The appellant argued that the TPO arbitrarily rejected the Transfer Pricing Documentation (TP Study) and conducted a fresh search for comparables based on non-contemporaneous data, which was inconsistent with Rule 10B(5) of the Rules. The DRP upheld the TPO's actions.

5. Application of Arbitrary Filters:
The appellant contended that the TPO/NFAC applied arbitrary filters to select comparables, such as software development services income to sales more than 75% and export services to sales more than 75%, which were not aligned with the appellant's qualitative filters.

6. Rejection of Comparables Selected by the Appellant:
The appellant argued that the TPO/NFAC and DRP erred in rejecting certain comparables selected by the appellant, including Sankhya Infotech Ltd., Evoke Technologies Pvt. Ltd., and others. The appellant also contested the exclusion of Kals Information Systems Ltd. as a comparable.

7. Selection/Rejection of Comparable Companies:
The appellant raised multiple issues regarding the selection and rejection of comparable companies, including the erroneous inclusion of R Systems International Limited, Mindtree Limited, Infosys Limited, and others. The appellant argued that these companies were not functionally comparable, had significant R&D activities, or earned abnormally high margins.

8. Adjustment Value on Software Development Income:
The appellant contended that the TPO/NFAC erred in not restricting the adjustment value on software development income to the extent of international transactions with Associated Enterprises.

9. Set-off of Brought Forward Business Losses and Unabsorbed Depreciation:
The appellant argued that the NFAC erred in not setting off brought forward business losses and unabsorbed depreciation.

10. Set-off of MAT Credit Entitlement:
The appellant contended that the NFAC erred in not setting off MAT credit entitlement pertaining to earlier assessment years.

11. Grant of Foreign Tax Credit:
The appellant argued that the NFAC erred in not granting Foreign Tax Credit, and the DRP did not adjudicate this ground of objection.

12. Grant of Interest under Section 244A:
The appellant contended that the NFAC erred in the short grant of interest under section 244A.

13. Issuance of Refund:
The appellant argued that the NFAC/AO erred in not issuing the refund due to the appellant after determining an income-tax refund.

14. Initiation of Penalty Proceedings:
The appellant contended that the AO erred in initiating penalty proceedings under section 274 read with section 270A.

15. Relief:
The appellant prayed for directions to grant all relief arising from the preceding grounds and consequential reliefs.

Judgment:

Ground No. 7.1:
The Tribunal noted that R Systems International Ltd. follows a different financial year and upheld the appellant's objection to its inclusion as a comparable. The Tribunal directed the TPO/AO to exclude R Systems International Ltd. from the list of comparables.

Ground No. 7.6:
The Tribunal considered the exclusion of three comparables on functional dissimilarity:
1. Persistent Systems Ltd.: The Tribunal found this company functionally dissimilar to the appellant, as it is engaged in outsourced software product development services and has significant R&D activities. The Tribunal directed the exclusion of Persistent Systems Ltd.
2. Nihilent Ltd.: The Tribunal found this company functionally dissimilar, as it is engaged in diverse activities, including business consulting and IT services. The Tribunal directed the exclusion of Nihilent Ltd.
3. OFS Technologies Ltd.: The Tribunal found this company functionally dissimilar, as it is engaged in outsourced product development and independent testing. The Tribunal directed the exclusion of OFS Technologies Ltd.

Ground No. 7.9:
The Tribunal considered the exclusion of three comparables on the basis of high margins:
1. Threesixty Logic Testing Services Pvt. Ltd.: The Tribunal directed the TPO/AO to verify the functional similarities of this company.
2. Cybage Software Ltd.: The Tribunal directed the TPO/AO to verify the functional similarities of this company.
3. Consilient Technologies Ltd.: The Tribunal directed the TPO/AO to verify the functional similarities of this company.

The Tribunal upheld the applicability of Rule 10CA of the I.T. Rules, subject to the verification of functional similarities. If the comparables are found to be functionally dissimilar, they may be excluded.

Conclusion:
The Tribunal partly allowed the appellant's appeal for statistical purposes, directing the exclusion of certain comparables and verification of functional similarities for others. The Tribunal did not consider other grounds as they were not argued before it.

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