AI TextQuick Glance (AI)Headnote
Issues: (i) Whether the disputed expenses and receipts were operating items for transfer-pricing margin computation; (ii) Whether the prescribed filters and comparable set for the software and engineering design services segment were correctly determined; (iii) Whether the distribution-segment comparable set, the scope of adjustment to associated-enterprise transactions, and the appropriate transfer-pricing method were correctly determined; (iv) Whether the contract-manufacturing comparable set was correctly determined; (v) Whether a working-capital adjustment was required; (vi) Whether notional interest on delayed associated-enterprise receivables was exigible; (vii) Whether intra-group service charges could be benchmarked at nil.
Issue (i): Whether the disputed expenses and receipts were operating items for transfer-pricing margin computation.
Analysis: For margin computation under the Transactional Net Margin Method, the character of an item depends on its source and nexus with ordinary business operations. Provisions for doubtful debts connected with trade receivables, routine rates and taxes, business-related miscellaneous receipts, and amortisation of deferred operating revenue retained their operating character. Consistency with the treatment accepted in an earlier year also supported the same treatment.
Conclusion: Provision for doubtful debts and advances, rates and taxes, miscellaneous income, and amortisation of deferred income must be treated as operating items in computing the margins of the assessee and comparable companies.
Issue (ii): Whether the prescribed filters and comparable set for the software and engineering design services segment were correctly determined.
Analysis: Rule 10B(2) and Rule 10B(3) require comparability to be assessed on functions performed, assets employed, risks assumed, and material economic differences. The persistent loss filter could exclude only companies incurring operating losses in all three relevant years, and could not be applied at the profit-before-tax level. The related party transaction filter had to be applied uniformly on aggregate related-party receipts and payments. A ten-times upper turnover filter was appropriate because substantially different operational scale, market reach, bargaining power and brand profile can affect economic comparability. A negligible shortfall from an export filter could not defeat an otherwise reliable comparable. Functional dissimilarity, extraordinary merger effects, failure of the related party transaction filter, specialised testing or high-end technology activities, and substantially different scale justified exclusion of unsuitable companies.
Conclusion: KALS Information Systems Ltd., Rheal Software Ltd. and Yudiz Solutions Pvt. Ltd. were directed to be included. Apttus Software Pvt. Ltd., Cybage Software Pvt. Ltd., Tata Elxsi Ltd., IndiaNIC Infotech Ltd., Nintec Systems Ltd., Orion India Systems Ltd., QSG Technologies Pvt. Ltd., Systango Technologies Ltd., Mindtree Ltd., LTIMindtree Ltd., Wipro Ltd., Infosys Ltd. and Tata Consultancy Services Ltd. were directed to be excluded, and the software-segment arm's length computation must be recomputed accordingly.
Issue (iii): Whether the distribution-segment comparable set, the scope of adjustment to associated-enterprise transactions, and the appropriate transfer-pricing method were correctly determined.
Analysis: Under Rule 10B, distributors of medical products can be comparable despite differences in the particular medical products traded, where their broad distribution functions remain similar. Incidental pre-sales, post-sales, installation or support services did not displace the primary distribution function. Companies engaged in materially different activities, including dental services, specialised dental-product distribution, support-service activities, or manufacturing of consumables, lacked the necessary functional similarity. Transfer-pricing adjustment must be confined to international transactions with associated enterprises and not extended to third-party turnover. Consistent earlier-year directions supported use of the Resale Price Method and comparison of gross margins for the distribution segment.
Conclusion: Ark Diagnostics Bangalore Pvt. Ltd., Hicks Thermometers (India) Ltd., Pika Medical Pvt. Ltd. and Exactech India Pvt. Ltd. were directed to be included, while Dental Avenue India Pvt. Ltd., IDS Denmed Pvt. Ltd., MDD Medical Systems (India) Pvt. Ltd. and Narang Medical Ltd. were directed to be excluded. Any adjustment must be restricted to associated-enterprise transactions, and the arm's length price must be determined by comparing gross margins under the Resale Price Method.
Issue (iv): Whether the contract-manufacturing comparable set was correctly determined.
Analysis: Product-level differences within the medical-products manufacturing field did not, without a demonstrated material difference in functions, assets or risks, negate comparability. Conversely, significant research and development functions, clinical-trial expenditure, and innovation-driven activities created material functional differences from routine contract manufacturing. The absence of stated reasons after verification could not sustain exclusion where the available material showed broadly similar medical-device manufacturing functions.
Conclusion: Centenial Surgical Suture Ltd., Healthium Medtech Ltd., Shree Pacetronix Ltd. and Vinod Medical Systems Pvt. Ltd. were directed to be included. Agappe Diagnostics Ltd. and Sahajanand Medical Technologies Ltd. were directed to be excluded from the contract-manufacturing comparable set.
Issue (v): Whether a working-capital adjustment was required.
Analysis: Rule 10B(1)(e) requires adjustment for material differences in receivables, payables and inventory that affect net margins. The available record did not contain a proper analysis based on average working-capital balances of the assessee and the comparables, although the adjustment was legally warranted.
Conclusion: The working-capital adjustment claim was restored for fresh computation after examination of the relevant average balances and supporting material.
Issue (vi): Whether notional interest on delayed associated-enterprise receivables was exigible.
Analysis: Delayed receivables may fall within the scope of an international transaction under Section 92B of the Income-tax Act, 1961. However, their inclusion does not automatically justify an adjustment. The assessee was debt-free, and no interest cost, financing arrangement, or benefit passed to an associated enterprise was established.
Conclusion: No notional-interest adjustment on delayed associated-enterprise receivables was warranted, and the adjustment was directed to be deleted.
Issue (vii): Whether intra-group service charges could be benchmarked at nil.
Analysis: The materials showed receipt of accounting, finance, legal, regulatory, technical-documentation, marketing and operational-support services. The commercial necessity of services cannot be substituted by the transfer-pricing authority's view of business prudence. A nil arm's length price could not be adopted without a proper comparability analysis, a valid selection of the Comparable Uncontrolled Price method under Rule 10C, or service-specific material establishing shareholder activity.
Conclusion: The nil arm's length price for intra-group services was unsustainable, and the corresponding transfer-pricing adjustment was directed to be deleted.
Final Conclusion: The transfer-pricing computation must be redetermined using the revised segment-wise comparable sets, correct operating margins and the specified transfer-pricing directions; the receivables and intra-group service adjustments stand deleted, while the working-capital adjustment requires fresh computation.
Transfer-pricing comparability requires functionally aligned benchmarks, AE-only adjustments, and deletion of unsupported receivables and service-charge adjustments.
Transfer-pricing margins under the Transactional Net Margin Method treat trade-receivable bad-debt provisions, rates and taxes, business-related receipts, and deferred operating-revenue amortisation as operating items. Comparable selection requires functional, asset and risk analysis, uniform related-party transaction filtering, and exclusion of entities affected by extraordinary events, high-end functions, or materially different scale. Distribution adjustments remain limited to associated-enterprise transactions and use gross-margin comparison under the Resale Price Method. Working-capital differences require average-balance analysis. Delayed associated-enterprise receivables do not warrant notional interest without demonstrated financing cost, arrangement, or benefit. Intra-group services cannot be priced at nil without valid method selection, comparability analysis, or evidence of shareholder activity; the segmental computation requires recomputation accordingly.
Operating margin computation in transfer pricing - Persistent loss filter - Related-party transaction filters - Functional comparability under TNMM - Upper turnover filter in software-service comparability - Resale Price Method for medical-product distribution - TP adjustment confined to associated-enterprise transactions - Working-capital adjustment under TNMM - Notional interest on delayed trade receivables - Arm's length price of intra-group services Operating and non-operating items in transfer-pricing margins - Treatment of provisions, statutory charges and business-related income items in computing operating margins - HELD THAT: - The operating character of an item depends upon its real nature and nexus with business operations, not merely its accounting description. Provision for doubtful debts arising from trade receivables, rates and taxes incurred in regular operations, miscellaneous business receipts, and amortisation of deferred revenue arising from operations were held to be operating items. Deferred recognition of operational revenue does not alter its underlying character. Respectfully following the order of the Coordinate Bench in the assessee's own case for AY 2021-22 [2026 (5) TMI 948 - ITAT BANGALORE] we direct the AO/TPO to treat provision for doubtful debts and advances (including reversals) and rates & taxes as operating in nature while computing the margins of the assessee as well as the comparable companies.[Paras 9, 14] The AO/TPO was directed to treat those items as operating income or expenditure, as applicable, in computing the margins of the assessee and comparable companies. Persistent loss filter - Application of the persistent loss filter in selecting comparables - HELD THAT: - A company cannot be treated as a persistent loss-maker merely because it incurred losses in two of the three relevant years. The filter must exclude only companies having losses in all three years and must be applied with reference to operating results rather than profit or loss at the PBT level. Case followed Altisource Business Solutions (P.) Ltd [2026 (7) TMI 772 - ITAT BANGALORE] [Paras 16] The AO/TPO was directed to apply the persistent loss filter only to companies having operating losses in all three relevant years. Aggregate related-party transaction filter - Method of computing the related-party transaction ratio for comparability analysis - HELD THAT: - The related-party transaction filter must be applied uniformly by aggregating related-party receipts and related-party payments. Separate computation of related-party receipts and payments does not reflect the aggregate extent of controlled dealings of a comparable. We find that an identical issue was considered in Toyota Kirloskar Motor (P.) Ltd. [2023 (2) TMI 1106 - ITAT BANGALORE] wherein it was held that the RPT percentage has to be computed by considering the aggregate of related party transactions[Paras 16] The AO/TPO was directed to compute the related-party transaction ratio on an aggregate basis. Functional comparability of software development service providers - Selection of comparables for the software and engineering design services segment of a provider of medical-equipment-linked software and value-engineering services - HELD THAT: - Functional analysis, rather than a broad description of revenue as software-development income, governs comparability. KALS Information Systems Ltd., Rheal Software Ltd. and Yudiz Solutions Pvt. Ltd. were found comparable, Yudiz's negligible shortfall from the export-revenue threshold being incapable of justifying exclusion. Conversely, companies undertaking onsite and R&D-intensive services, diversified high-end design services, specialised technology services, software testing and quality-assurance functions, or services without reliable segmentation of specialised operations were functionally dissimilar. Software testing, though part of the development lifecycle, is not equivalent to software development. [Paras 26, 27, 29, 30, 31] KALS Information Systems Ltd., Rheal Software Ltd. and Yudiz Solutions Pvt. Ltd. were directed to be included; Cybage Software Pvt. Ltd., Tata Elxsi Ltd., Indianic Infotech Ltd., Orion India Systems Ltd., QSG Technologies Pvt. Ltd. and Systango Technologies Ltd. were directed to be excluded. Extraordinary event in multi-year comparability analysis - Reliability of Apttus Software Pvt. Ltd.'s weighted-average margin after its merger with Conga - HELD THAT: - The precedent concerning Aptus Software Labs Pvt. Ltd. In [2026 (5) TMI 948 - ITAT BANGALORE] did not govern the distinct company, Apttus Software Pvt. Ltd. On an independent examination, the merger constituted an extraordinary event in one of the three years used for computing the weighted-average margin. Where such an event can materially affect financial results, the reliability of the weighted-average margin is doubtful even if its precise effect is not quantified. [Paras 24] Apttus Software Pvt. Ltd. was directed to be excluded from the final set of software-development comparables. Related-party transaction filter in multi-year data - Retention of Nintec Systems Ltd. despite failure of the related-party transaction filter in most years used for its weighted-average margin - HELD THAT: - Functional similarity alone cannot preserve a comparable which does not satisfy the quantitative filters uniformly applied by the TPO. A company that fails the related-party transaction threshold in two of the three years used for the weighted-average margin cannot ordinarily be treated as an uncontrolled comparable merely because it satisfies the filter in one year. [Paras 28] Nintec Systems Ltd. was directed to be excluded from the final set of comparables. Upper turnover filter for software-service comparables - Application of an upper turnover filter in selection of software-development comparables - HELD THAT: - Turnover is a relevant economic circumstance in comparability analysis; its relevance does not depend upon proving a direct mathematical correlation between turnover and operating margin. Having applied a lower turnover filter, the Revenue could not treat turnover as irrelevant at the upper end. Companies operating at substantially different scales may differ in market reach, customer base, bargaining power, employee strength, resource deployment and brand advantage. A turnover range of ten times the assessee's turnover was therefore held appropriate; Mindtree Ltd. was also distinguishable by its market-facing brand profile. [Paras 38] LTIMindtree Ltd., Wipro Ltd., Infosys Ltd., Tata Consultancy Services Ltd., Tata Elxsi Ltd. and Mindtree Ltd. were directed to be excluded from the software-development comparable set. Functional comparability in medical-product distribution - Selection of comparables for the distribution of medical and diagnostic products - HELD THAT: - Exact identity of medical products is not required where the broad functions of trading and distribution of medical products are comparable. Product diversity and incidental pre-sale, post-sale, installation or support services did not displace the comparability of Ark Diagnostics Bangalore Pvt. Ltd., Hicks Thermometers (India) Ltd., Pika Medical Pvt. Ltd. and Exactech India Pvt. Ltd. Their treatment in the preceding year and the absence of material changes also supported inclusion. Conversely, companies engaged in dental services or dental materials, support services for operation-theatre products, or manufacture of medical consumables were functionally different from the assessee's distribution activity. [Paras 43, 45, 46, 47, 48] Ark Diagnostics Bangalore Pvt. Ltd., Hicks Thermometers (India) Ltd., Pika Medical Pvt. Ltd. and Exactech India Pvt. Ltd. were directed to be included; Dental Avenue India Pvt. Ltd., IDS Denmed Pvt. Ltd., MDD Medical Systems (India) Pvt. Ltd. and Narang Medical Ltd. were directed to be excluded. Transfer-pricing adjustment limited to associated-enterprise transactions - Scope of the transfer-pricing adjustment in the distribution segment - HELD THAT: - An arm's length adjustment can be made only in respect of international transactions undertaken with associated enterprises and cannot be extended to the entire turnover of the relevant segment. [Paras 51] Any transfer-pricing adjustment was directed to be restricted to the assessee's international transactions with its associated enterprises. Resale Price Method for distribution transactions - Determination of the arm's length price for the medical-products distribution segment - HELD THAT: - In the absence of a material change in facts, consistency required adherence to the earlier treatment of the assessee's distribution segment [2023 (5) TMI 1352 - ITAT BANGALORE]. The arm's length price was required to be determined by comparing gross margins under the Resale Price Method rather than entity-level net margins under TNMM. [Paras 53] The AO/TPO was directed to compare the assessee's gross margin with the gross margins of the final comparables for determining the arm's length price. Functional comparability in contract manufacturing of medical products - Selection of comparables for contract manufacturing of medical products - HELD THAT: - Differences in the particular medical products manufactured do not, by themselves, establish functional dissimilarity where both enterprises broadly manufacture medical products and no material FAR difference is shown. Cryptic rejection after directions for FAR examination could not sustain exclusion, particularly where the lower authorities had themselves recorded comparable functions, assets and risks. However, manufacturers undertaking substantial research and development, clinical trials and innovation-driven activities were functionally different from the assessee's contract-manufacturing activity. [Paras 56, 57, 58, 59, 60] Centenial Surgical Suture Ltd., Healthium Medtech Ltd., Shree Pacetronix Ltd. and Vinod Medical Systems Pvt. Ltd. were directed to be included; Agappe Diagnostics Ltd. and Sahajanand Medical Technologies Ltd. were directed to be excluded. Working-capital adjustment under TNMM - Grant of working-capital adjustment for differences in receivables, payables and inventory - HELD THAT: - Differences in working-capital levels may materially affect net margins under TNMM and require examination under the transfer-pricing rules. The lower authorities had not conducted a proper analysis based on average balances of the assessee and comparables. Consistency with the earlier year also supported grant of the adjustment. [Paras 67] The matter was restored to the AO/TPO to compute and grant the working-capital adjustment in accordance with law after examining the requisite average balances and supporting material. Notional interest on delayed receivables of a debt-free entity - Transfer-pricing adjustment for interest on delayed realisation of trade receivables from associated enterprises - HELD THAT: - Delayed receivables fall within the ambit of an international transaction, but their inclusion does not automatically justify an adjustment. Where the assessee is debt-free, has incurred no interest cost and the Revenue has not established a financing arrangement or benefit passed to the associated enterprises, mere delay in collection cannot warrant imputation of notional interest. [Paras 72] The adjustment for notional interest on delayed receivables was directed to be deleted. Arm's length price of intra-group services - Determination of the arm's length price of intra-group operational support services at nil - HELD THAT: - The material showed receipt of accounting, finance, legal, regulatory, technical-documentation, marketing and operational support services. The TPO cannot substitute its commercial judgment for that of the assessee once actual receipt and business use of services are demonstrated. Further, the price could not be fixed at nil under CUP without identifying a comparable uncontrolled transaction, conducting the prescribed comparability analysis, or separately showing that particular services were shareholder activities. [Paras 77] The transfer-pricing adjustment on intra-group service charges was directed to be deleted. Final Conclusion: The appeal was partly allowed for statistical purposes. The transfer-pricing adjustments were directed to be recomputed in accordance with the revised comparable sets and directions, while the adjustments for delayed receivables and intra-group service charges were deleted.