2023 (8) TMI 1170 - AT - Income Tax

Transfer pricing comparable selection and FAR analysis require re-verification of comparables and recomputation of operating margins

Transfer pricing review focuses on comparable selection and FAR analysis for a captive service provider operating on a cost plus markup. Functional ... Admission of additional grounds - transfer pricing comparability analysis - functional comparability - application of quantitative and qualitative filters in comparable search (turnover, RPT, export revenue, employee cost, persistent loss) - treatment of provision for bad and doubtful debts in computation of operating profit - remand for verification and re-computation by AO/TPOAdmission of additional grounds - Admission of additional grounds of appeal filed by the assessee - HELD THAT: - The Tribunal admitted the additional grounds filed on 19.08.2022 and 17.02.2023. It found that the additional grounds were directly connected with the main transfer pricing issue and did not require investigation of new facts. The Tribunal followed precedents permitting admission to render complete justice and held the additional grounds admissible for adjudication.Additional grounds dated 19.08.2022 and 17.02.2023 are admitted.Transfer pricing comparability analysis - functional comparability - application of quantitative and qualitative filters in comparable search (turnover, RPT, export revenue, employee cost) - Exclusion of specified comparables from the final set for benchmarking the SWD segment - HELD THAT: - On examining the FAR and the nature of the assessee as a captive contract service provider with limited risks and no significant intangibles, the Tribunal held that certain large and diversified companies are functionally dissimilar and ought to be excluded. Relying on coordinate-bench precedents and the factual material (including absence of segmental reporting, presence of significant onsite activity, R&D/intangible ownership and high turnover disproportionate to the assessee), the Tribunal directed exclusion of Larsen & Toubro Infotech Ltd., Mindtree Ltd., Persistent Systems Ltd. and Infosys Ltd. It also directed exclusion of Nihilent Ltd. and OFS Technologies Ltd. after considering prior Tribunal decisions and the functionality/segmental reporting issues.Directed exclusion of Larsen & Toubro Infotech Ltd., Mindtree Ltd., Persistent Systems Ltd., Infosys Ltd., Nihilent Ltd. and OFS Technologies Ltd. from the final list of comparables.Remand for verification and re-computation by AO/TPO - Inclusion of Maveric Systems Ltd. and Evoke Technologies Pvt. Ltd. and verification of their comparability - HELD THAT: - The Tribunal observed that authorities below had not verified the annual reports to determine whether these entities satisfy the export revenue and other filters. In the interests of justice it remitted the matter to the AO/TPO for verification of FAR of these comparables and directed consideration for inclusion if they meet the relevant filters.Maveric Systems Ltd. and Evoke Technologies Pvt. Ltd. are remitted to the AO/TPO for verification of FAR and filters; Additional Ground 1(b) is partly allowed.Remand for verification and re-computation by AO/TPO - Re-computation of margins of specified comparables for statistical purposes - HELD THAT: - The Tribunal found that margins of Harbinger Systems Pvt. Ltd. and CG-Vak Software and Exports Ltd. were wrongly computed and directed the AO/TPO to recompute their margins in accordance with law for statistical use in the comparability analysis.Directed recomputation of margins of Harbinger Systems Pvt. Ltd. and CG-Vak Software and Exports Ltd.; Additional Ground No.2 (19.08.2022) allowed for statistical purposes.Treatment of provision for bad and doubtful debts in computation of operating profit - Whether provision for bad and doubtful debts and bad debts should be treated as operating expenses when computing PLI of comparables - HELD THAT: - After reviewing coordinate-bench decisions and relevant authority, the Tribunal accepted the assessee's submissions that provision for bad and doubtful debts should be treated as operating in nature for the purpose of computing operating profit of comparable companies. The Tribunal noted precedents where such treatment was directed and observed that if the provision is taken as operating in the assessee's books, the same principle must apply to comparables.Directed AO/TPO to treat bad debts and provision for bad and doubtful debts as operating expenses while computing the PLI of comparable companies; Additional Ground No.2 (17.02.2023) allowed.Final Conclusion: The Tribunal partly allowed the appeal: it admitted the additional grounds, directed exclusion of six specified comparables from the final set, remitted two proposed comparables (Maveric and Evoke) to the AO/TPO for verification, directed recomputation of margins for two comparables for statistical purposes, and directed that bad and doubtful debts/provisions be treated as operating expenses in computing comparables' PLI; the remaining grounds were left open for future contest in appropriate circumstances. Issues Involved:1. General grounds challenging the assessment order.2. Grounds relating to transfer pricing matters.3. Consequential grounds regarding penal proceedings and demand notice.4. Admission of additional grounds of appeal.5. Specific comparables for inclusion/exclusion in transfer pricing analysis.Summary:General Grounds:1. The assessee challenged the assessment order dated 25.01.2022, contending it is erroneous, bad in law, and contrary to the facts and circumstances of the case.Transfer Pricing Matters:2. The AO erred by not following the DRP's binding directions, failing to grant appropriate relief to the appellant.3. An addition of INR 19,65,61,201 was made to the appellant's total income due to adjustment in the arm's length price (ALP) for international transactions with its associated enterprise.4. The AO/TPO/DRP erred by not accepting the appellant's economic analysis and conducting a fresh analysis, incorrectly applying quantitative and qualitative filters, rejecting and accepting certain comparables, and not making suitable adjustments for differences in working capital and risk profiles. The adjustment was not restricted to international transactions, affecting third-party transactions as well.Consequential Grounds:5. The AO erred in initiating penal proceedings under section 274 read with section 270A of the Act.6. The AO erred in issuing a demand notice under section 156 of the Act.Admission of Additional Grounds:2.1 The assessee filed applications on 19.08.2022 and 17.02.2023 seeking admission of additional grounds for inclusion/exclusion of specific comparables without requiring verification of new facts.2.2 The CIT-DR opposed the admission but could not challenge the assessee's right under the Act.2.3 The Tribunal admitted the additional grounds, noting they are directly connected with the main issue of transfer pricing additions.Specific Comparables:8. The assessee sought exclusion of six comparables (Larsen & Toubro Infotech Ltd., Mindtree Ltd., Persistent Systems Ltd., Nihilent Ltd., OFS Technologies Ltd., and Infosys Ltd.) due to failure to satisfy the turnover filter and functional dissimilarities. The Tribunal directed the exclusion of these comparables based on precedents.9. The assessee sought inclusion of Maveric Systems Ltd. and Evoke Technologies Pvt. Ltd., which were remanded back to the AO/TPO for verification of FAR analysis and relevant filters.10. The Tribunal directed the AO/TPO to recompute the margins of Harbinger Systems Pvt. Ltd. and CG-Vak Software and Exports Limited.11. The Tribunal directed the AO to consider bad debts and provision for bad debts as operating expenses while computing the operating margin of comparable companies, following precedents.Conclusion:The appeal filed by the assessee was partly allowed, with specific directions for exclusion and inclusion of comparables and recomputation of margins, while other grounds and comparables not argued were left open for future contestation.