2023 (2) TMI 1427 - AT - Income Tax

TPO instructed to apply Rs.200 crore turnover cap, exclude certain comparables, and compute interest at LIBOR+2%

Marlabs Innovations Private Ltd Versus The Deputy Commissioner of Income Tax, Circle 4 (1) (1), Bengaluru.

ITAT (Bangalore) directed the TPO to apply an upper turnover filter and exclude comparables with turnover exceeding Rs.200 crore in the software ... TP Adjustment - Comparable selection - HELD THAT:- We notice that the turnover of assessee in SWD segment is 99.29 crores and in ITeS segment 18.88 crores. Respectfully following the decision of Altair Engineering India P. Ltd [2023 (4) TMI 674 - ITAT BANGALORE] we direct the TPO to apply upper turnover filter and exclude the companies having turnover of more than Rs.200 crores in SWD and ITeS segments including companies sought to be excluded through additional ground. Exclusion of only Domex E Data P. Ltd. from ITeS segment - We notice that the profile of the assessee is providing SWD and ITeS services which is similar to Altair Engg. Therefore we direct the TPO to exclude Domex E Data P. Ltd. from the list of comparables. Incorrect adjustment on account of notional interest on outstanding receivables - TPO determined a notional interest as arm's length remuneration for the receivables outstanding from the AE by applying LIBOR+450 points - HELD THAT:- As relying on TIVO TECH PRIVATE LIMITED [2023 (2) TMI 837 - ITAT BANGALORE] the interest on receivable is a separate international transaction as has been rightly considered by the lower authorities. With regard to calculation of interest, we place reliance on the judgment of Aurionpro Solutions Ltd [2017 (6) TMI 1087 - BOMBAY HIGH COURT] and direct the TPO to consider the interest at the rate of LIBOR rate + 2%. The TPO is also directed to consider a credit period of 30 days considering the fact the assessee has collected the payments against the receivables within a period of 90 days as submitted by the ld AR. It is ordered accordingly. AO restricting the TDS credit and credit for advance tax - We noticed that the assessee has submitted the relevant documents with regard to amalgamation before the lower authorities and the same have not been considered while giving credit for TDS. We therefore remit the issue back to the AO with a direction to consider the TDS and advance tax in the name of Marlab Software P. Ltd. and decide the issue in accordance with law. 1. ISSUES PRESENTED AND CONSIDERED 1. Whether the TPO/DRP were justified in refusing to apply an upper turnover filter (Rs.200 crores) when selecting comparable companies under TNMM for Software Development (SWD) and IT-enabled Services (ITeS) segments. 2. Whether Domex E Data Pvt. Ltd. (a KPO) is a comparable for benchmarking the ITeS segment or should be excluded on functionality grounds. 3. Whether notional interest on outstanding receivables from associated enterprises constitutes a separate international transaction requiring benchmarking, and if so, the appropriate interest rate and interest-free period to be applied. 4. Whether TDS and advance tax credits standing in the name of the predecessor (merged) entity were rightly ignored by the AO and require adjustment in the assessee's assessment. 5. Admissibility of additional grounds raised by the assessee in appeal (application of NTPC principle). 2. ISSUE-WISE DETAILED ANALYSIS Issue 1 - Application of upper turnover filter for selection of comparables under TNMM (SWD and ITeS segments) Legal framework: Transfer Pricing Regulations under the Act; TNMM with Operating Profit/Operating Cost as the Profit Level Indicator; concept of comparability including size/turnover as a relevant characteristic for selecting comparables. Precedent Treatment: Conflicting coordinate-bench Tribunals and non-jurisdictional High Court decisions exist on whether high turnover alone is a valid ground for excluding comparables. The Tribunal followed coordinate-bench decisions (e.g., Dell International, Autodesk, Genisys Integrating) endorsing an upper turnover filter (Rs.1 crore-200 crores band per Dun & Bradstreet approach) and the view of the Hon'ble Bombay High Court in Pentair favoring turnover as relevant. Interpretation and reasoning: The Court accepted that size/turnover materially affects bargaining power, customer base, skilled resources and hence profit margins; exclusion of loss-making comparables by TPO logically requires symmetrical exclusion of super-profit making/high-turnover companies to avoid skewing benchmark margins. Given absence of binding jurisdictional High Court contrary view, where conflicting authoritative views exist, the Tribunal follows the view favorable to the taxpayer. The coordinate-bench methodology (upper turnover filter of Rs.200 crores) was found appropriate to ensure comparability with the assessee's turnover (SWD ~Rs.99.29 crores; ITeS ~Rs.18.88 crores post adjustments). Ratio vs. Obiter: Ratio - application of upper turnover filter (exclusion of comparables with turnover > Rs.200 crores) is a determinative holding applying directly to the assessment of ALP. The discussion distinguishing contrary decisions is ratio for the Tribunal's choice of precedent; references to obiter in other High Court decisions were noted. Conclusions: The TPO is directed to apply the upper turnover filter and exclude companies with turnover exceeding Rs.200 crores from comparable lists in both SWD and ITeS segments (including those identified through admitted additional grounds). TPO to recompute ALP accordingly. Issue 2 - Exclusion of Domex E Data Pvt. Ltd. (KPO) from ITeS comparables Legal framework: Functional comparability principle in transfer pricing; comparability requires similarity in functions, risks and assets (KPO v. ITeS distinction). Precedent Treatment: Coordinate-bench decisions (including Altair Engineering) examined whether KPO firms are comparable to ITeS firms and excluded Domex E Data where functionality differed; other Tribunals have held KPO and ITeS to be distinct in relevant cases. Interpretation and reasoning: The Tribunal observed that the assessee's profile (provision of SWD and ITeS) aligns with the factual matrix in the coordinate decision excluding Domex E Data because KPO service profile is functionally different from ITeS. Given functional dissimilarity, inclusion of Domex would impair comparability. Ratio vs. Obiter: Ratio - Domex E Data to be excluded from ITeS comparable set. The functional comparability rationale is operative and necessary for ALP determination. Conclusions: Domex E Data Pvt. Ltd. is excluded from the comparable set for the ITeS segment; TPO directed to revise comparables and recompute ALP accordingly. Issue 3 - Notional interest on outstanding receivables: characterization, benchmarking, rate and credit period Legal framework: Explanation to section 92B (definition of 'international transaction' to include deferred payment/receivable/debt arising during course of business); transfer pricing treatment requires benchmarking of international transactions; TNMM and working capital adjustments considerations; commercial principles for interest rate determination (LIBOR usage for foreign-currency receivables). Precedent Treatment: Coordinate-bench and High Court decisions considered include Swiss Re Global Business Solutions, AMD (Karnataka HC), Aurionpro (Bombay HC), and a body of Tribunal/High Court authorities debating whether trade receivables are independent international transactions or subsumed within main transaction/working capital adjustments. The Tribunal relied on coordinate-bench conclusions treating deferred receivables as independent international transactions and accepting LIBOR + a spread as appropriate. Interpretation and reasoning: The Tribunal held that receivables arising in foreign currency with associated enterprises constitute an international transaction under the Explanation to section 92B and warrant independent benchmarking. The working capital adjustment may subsume certain effects, but that does not preclude separate examination of receivables where they represent a distinct benefit or financing arrangement. For rate determination, commercial practice requires application of LIBOR for foreign-currency financing; the Tribunal considered precedent and directed LIBOR + 2% (declining from TPO's LIBOR+450 bps and other arbitrary spreads). Regarding the interest-free period, the Tribunal directed a 30-day credit period as reasonable in light of facts (assessee collected payments within 90 days) and to avoid computing interest from invoice date without any grace period. Ratio vs. Obiter: Ratio - (a) deferred receivables from AE are an independent international transaction requiring benchmarking; (b) interest to be benchmarked at LIBOR + 2%; (c) a 30-day credit period to be allowed. Observations about alternative authorities and the need for fact-specific working capital analysis are instructive but secondary. Conclusions: The Tribunal affirmed that notional interest on receivables is a separate international transaction. The TPO is directed to recompute notional interest applying LIBOR + 2% and allowing a 30-day interest-free period, with opportunity for the assessee to be heard on facts affecting working capital impact. Issue 4 - Credit for TDS and advance tax standing in the name of predecessor following merger Legal framework: Principles governing credit for TDS and advance tax, recognition of tax credits of predecessor entities on amalgamation/merger, and administrative assessment procedure to give effect to documentary evidence. Precedent Treatment: The Tribunal noted submissions and materials filed before the AO; no novel precedent extended or overruled. Interpretation and reasoning: The assessee produced amalgamation documents and financial statements showing TDS/advance tax credits in the name of the predecessor. The AO did not consider those documents when granting credit. Given that the material was on record and relevant to tax credits, the appropriate remedy is remand to the AO to consider and decide the matter in accordance with law after examining the submitted documents. Ratio vs. Obiter: Ratio - matter remitted to AO for reconsideration of TDS and advance tax credit standing in predecessor's name. Procedural direction is binding for further assessment proceedings in the year in question. Conclusions: Issue remitted to AO with direction to examine and grant credit for TDS and advance tax in the name of the predecessor company where appropriate; consequential adjustments to be made in accordance with law. Issue 5 - Admissibility of additional grounds Legal framework: Procedural discretion to admit additional grounds where they do not raise fresh issues; reference to Supreme Court principle in NTPC (M/s National Thermal Power Co. Ltd.). Precedent Treatment: Reliance on NTPC principle to admit additional grounds that do not require fresh adjudication. Interpretation and reasoning: The Tribunal exercised discretion to admit additional grounds (exclusion of certain companies via upper turnover filter) because they do not introduce new issues and are covered by existing arguments and precedents. Ratio vs. Obiter: Ratio - additional grounds admitted for adjudication under NTPC principle; procedural determination. Conclusions: Additional grounds admitted; related comparables considered and directed to be excluded where turnover exceeds Rs.200 crores as per substantive rulings above. Overall disposition: Appeal partly allowed; directions given to exclude specified high-turnover comparables (including Domex E Data), to treat receivables as separate international transactions benchmarked at LIBOR + 2% with 30-day credit period, to recompute ALP accordingly, and to remit TDS/advance tax credit issue to AO for fresh decision.