2022 (9) TMI 1675 - AT - Income Tax

Order excludes comparables with turnover and related-party mismatches, remands computations and directs re-examination of working-capital and comparable adjustments

M/s. ContinuServe Softech India Pvt. Ltd. Versus ITO, National e-Assessment Centre, Delhi.

ITAT directed exclusion of several listed comparables whose turnover exceeded the assessee's threshold and ordered that one comparable's margins for FY ... TP Adjustment - determination of ALP for provision of SWD services - choice of comparable companies - contention of the Assessee before the DRP was that while the TPO excluded companies with low turnover, he failed to apply the same yardstick to exclude companies with high turnover compared to the Assessee - Application of turnover filter - HELD THAT:- 7 companies listed in Grd.No.4.3 other than R.S.Software (india) Ltd., raised by the Assessee whose turnover in the current year is more than Rs.200 Crores should be excluded from the list of comparable companies. R.S. Software (India) Pvt.Ltd. admittedly a turnover of above Rs.200 crores in FY 2013-14 & 2014-15 and hence is not a comparable company in those two Financial Years and therefore while computing the average profit margin of three financial years, the profit margins of these two Financial Years 2013-14 & 2014-15 should be excluded and only margins for FY 16-17 should be taken for working out the average profit margin of this company. Company Inteq Software Pvt.Ltd. for FY 2013-14 had related Party transaction of more than 15% i.e., 17.62% and hence this company will not be regarded as comparable company for that year and therefore while computing the average profit margin of three financial years, the profit margins of the Financial years 2013-14 should be excluded and only margins for FY 2014-15 & 2016-17 should be taken for working out the average profit margin of this company. Incorrect computation of profit margins of CG VAK Software and Exports Ltd.- TPO in the order giving effect to the directions of the DRP has however not considered the plea of the Assessee as directed by the DRP. Hence, we deem it fit and appropriate to set aside the order of the AO on this aspect and direct the TPO/AO to verify the profit margin of this company and the claim of the Assessee after affording the Assessee opportunity of being heard. Excluding Infobeans Technologies Ltd., from the list of comparable companies - Bengaluru Bench of the Tribunal in the case of Prism Networks Pvt. Ltd [2022 (2) TMI 1296 - ITAT BANGALORE] as well as BORQS Software Solutions Pvt. Ltd. [2021 (10) TMI 1351 - ITAT BANGALORE] has upheld the inclusion of Infobeans Technologies Ltd. In the given facts and circumstances of the case, we are of the view that it would be just and appropriate to set aside the issue with regard to comparability of Infobeans Technologies Ltd., to the TPO/AO for fresh consideration to verify the claim of the assessee based on the decisions cited by the learned Counsel for the assessee and verification of facts. The TPO/AO will verify the factual details and decide the issue of comparability of this company afresh after affording assessee opportunity of being heard. Adjustment towards working capital - As far as the Assessee is concerned, the facts and figures with regard to his business has to be furnished. Regarding comparable companies, one has to fall back upon only on the information available in the public domain. If that information is insufficient, it is beyond the power of the Assessee to produce the correct information about the comparable companies. The Revenue has on the other hand powers to compel production of the required details from the comparable companies. If that power is not exercised to find out the truth then it is no defence to say that the Assessee has not furnished the required details and on that score deny adjustment on account of working capital differences. One has to see that reasonable adjustment is being made so as to bring both comparable and test party on same footing. The issue with regard to the grant of working capital adjustment should be directed to be examined by the TPO/AO afresh in the light of the decision of the tribunal referred to above, after affording opportunity of being heard to the Assessee. ISSUES PRESENTED AND CONSIDERED 1. Whether comparables having substantially higher turnover than the tested party can be excluded from the comparable set for transfer-pricing analysis (application of turnover/size filter under Rule 10B and Sec. 92C/92CA). 2. Whether, where a purported comparable's financial years fall outside comparability filters (turnover/RPT), those years' margins must be excluded when computing the company's average margin for the comparable set. 3. Whether companies rejected by the Transfer Pricing Officer (TPO) because they did not appear in the TPO's search matrix must be summarily excluded without fresh verificatory consideration of functional comparability or publicly available information. 4. Whether the TPO/AO must verify and rectify alleged computation errors in the profit margin of a selected comparable when the taxpayer produces documentary evidence contesting database figures. 5. Whether a working-capital adjustment is required to make comparables and the tested party reasonably comparable under Rule 10B(1)(e)(iii) and relevant OECD guidance, and if so, whether the TPO/AO erred in refusing such adjustment. ISSUE-WISE DETAILED ANALYSIS Issue 1 - Exclusion of high-turnover companies from the comparable set Legal framework: Determination of ALP by an appropriate method (TNMM here) is governed by Rule 10B and Sec. 92C/92CA; comparability (Rule 10B(2)-(3)) requires consideration of functions, assets and risks and permits adjustments for material differences. Precedent treatment: The Tribunal noted conflicting decisions from coordinate Benches and High Courts - some authorities hold high turnover is not ipso facto a ground for exclusion, while others (including a view adopted by certain co-ordinate Benches) treat turnover/size as a relevant filter. Where two views exist, the Tribunal followed the view favorable to the taxpayer and prior coordinate Bench decisions accepting turnover as relevant. Interpretation and reasoning: The Tribunal read Rule 10B and comparability principles to permit the use of turnover/size filters because size materially affects bargaining power, economies, cost structures and profit margins. Where TPO applied a lower turnover threshold to exclude very small companies, parity requires application of an upper threshold to exclude very large entities whose market position and cost-structure are not reflective of the tested party. The Tribunal relied on prior reasoning that, if loss-making or abnormally small entities are excluded for reliability, super-large entities should likewise be excluded to avoid skewing results. Ratio vs. Obiter: Ratio - the holding that comparables with significantly higher turnover than the tested party can be excluded is applied to the facts. Conclusion: Seven listed high-turnover companies (other than R.S. Software in certain years addressed separately) were held to be excludable from the comparable set as not comparable on size grounds; application of turnover filter upheld. Issue 2 - Exclusion of particular years' margins for a comparable when that year fails comparability filters Legal framework: Rule 10B(3) permits an uncontrolled transaction to be comparable only if differences do not materially affect profit or reasonably accurate adjustments can be made; proviso to Rule 10B(4) permits use of prior years' data only if such data could influence determination of transfer prices. Precedent treatment: The Tribunal relied on earlier co-ordinate decisions (including BORQS and Prism) that excluded specific years' data where that year's metrics failed comparability filters (e.g., turnover or related-party transaction filters). Interpretation and reasoning: If a particular year's data for a potential comparable shows attributes (e.g., turnover above a threshold or excessive related-party transactions) that render that year non-comparable, then that year's margin cannot reliably influence the ALP determination for the current year and must be ignored; the remaining years may be used to compute the company's average margin. Ratio vs. Obiter: Ratio - applied to remove FY 2013-14 & FY 2014-15 margins of R.S. Software and FY 2013-14 margin of Inteq where those years failed filters. Conclusion: Where a comparable's particular financial years fail comparability filters (turnover/RPT), those years' margins are to be excluded and only the comparable years retained for computing that company's average margin. Issue 3 - Inclusion of companies absent from the TPO's search matrix (alleged 'cherry-picking') Legal framework: Rule 10B comparability analysis requires functional comparability and consideration of public domain information; TPO/AO must consider claims supported by available information. Precedent treatment: The Tribunal cited recent decisions (Prism, BORQS) directing remand to TPO/AO for fresh consideration where DRP rejected inclusion solely because a company did not appear in the TPO's search matrix. Interpretation and reasoning: Rejection merely because a company did not appear in the TPO's initial search matrix amounts to improper shortcutting of functional comparability analysis and can amount to unjustified 'cherry-picking.' Where taxpayer shows publicly available or other evidence that a company is functionally comparable, the TPO/AO must independently verify and cannot simply decline consideration on that basis. Ratio vs. Obiter: Ratio - remand ordered for fresh consideration rather than affirming summary rejection. Conclusion: The issue of inclusion of companies not present in the TPO's search matrix is set aside and remitted to TPO/AO for fresh consideration and verification after affording the taxpayer an opportunity to be heard. Issue 4 - Verification and rectification of alleged errors in comparable's margin computation Legal framework: TPO/AO may rely on public databases, but if taxpayer produces documentary evidence showing discrepancies, Rule 10B comparability and principles of fair procedure require verification and correction where justified. Precedent treatment: DRP directed TPO to verify the claimed computation errors and rectify margins if documentary proof is provided; Tribunal found TPO did not comply with that direction in the assessment working paper and thereby remanded. Interpretation and reasoning: Where taxpayer submits evidence that database figures differ from statutory filings/annual reports, TPO must examine documentary materials and, if merited, correct the dataset to ensure ALP computation is based on accurate inputs. Ratio vs. Obiter: Ratio - remand for verification and opportunity to be heard. Conclusion: The computation of the comparable's profit margin is to be re-verified by the TPO/AO and corrected if the taxpayer's documentary evidence establishes an error; matter remitted for action after hearing. Issue 5 - Working-capital adjustment: whether it should have been allowed Legal framework: Rule 10B(1)(e)(iii) and OECD Transfer Pricing Guidelines contemplate comparability adjustments, including working-capital adjustments, to account for differences materially affecting margins. Precedent treatment: The Tribunal noted decisions both granting and denying working-capital adjustments; it relied on Tribunal decisions (e.g., Huawei) that applied OECD guidance to require or permit working-capital adjustments when differences in receivables, payables or inventory materially affect profits and reliable adjustments can be made. Interpretation and reasoning: OECD guidance explains the economic rationale (time value of money, financing needs) and methods for working-capital adjustments while acknowledging practical difficulties (timing of balance-sheet items, selection of interest rates). The DRP's generalized refusal - citing lack of data, mixed accounting practices and varied cost of capital - does not foreclose a working-capital adjustment where reasonable adjustments can improve reliability and the data permits; revenue should use its powers to obtain required information for comparables where public data is insufficient. Ratio vs. Obiter: Ratio - the Tribunal directed the TPO/AO to re-examine the working-capital adjustment issue in light of OECD guidance and relevant Tribunal precedent, after affording opportunity to be heard. Conclusion: The question of working-capital adjustment is remitted to TPO/AO for fresh consideration consistent with OECD guidelines and relevant Tribunal authority; the TPO/AO must examine whether reasonable and reliable adjustments can be made and call for further information if necessary. Overall Disposition The ALP computation is to be revisited by the TPO/AO in light of the foregoing directions: (a) exclusion of identified high-turnover comparables and removal of non-comparable years for certain companies; (b) remand for fresh consideration of inclusion of companies absent from the TPO search matrix and for verification of contested margin computations; (c) re-examination of working-capital adjustment as appropriate; all after affording the taxpayer an opportunity of being heard. The appeal is partly allowed.