2025 (6) TMI 41 - AT - Income Tax

Transfer pricing adjustments upheld with comparable company exclusions and working capital adjustments approved

M/s. DSM Shared Services India Pvt. Ltd. Versus Asst. Commissioner of Income Tax, Circle-8 (1), Hyderabad

M/s. DSM Shared Services India Pvt. Ltd. Versus Asst. Commissioner of Income Tax, Circle-8 (1), Hyderabad - TMI 1. ISSUES PRESENTED and CONSIDEREDThe core legal questions considered in this appeal relate primarily to transfer pricing adjustments and procedural compliance under the Income Tax Act, 1961. The key issues include:Validity and jurisdictional competence of the final assessment order passed under sections 143(3) read with 144C(13) and compliance with section 144B of the Act.Appropriateness of transfer pricing adjustments made by the Transfer Pricing Officer (TPO) and upheld by the Dispute Resolution Panel (DRP), specifically concerning:The international transaction involving provision of IT enabled back-office services.The levy of notional interest on trade receivables from associated enterprises (AEs).Rejection of the assessee's transfer pricing documentation maintained in good faith.Selection and exclusion/inclusion criteria of comparable companies for benchmarking, including the application of turnover filters.Denial of working capital adjustment (WCA) and risk adjustment in determining the arm's length price (ALP).Computation of adjustments at entity level rather than segment level.Appropriateness of the interest rate applied for benchmarking interest on trade receivables, including whether to apply the State Bank of India (SBI) short term deposit rate or the London Interbank Offered Rate (LIBOR) plus mark-up.Levy of interest under section 234B and initiation of penalty proceedings under sections 270A read with 274.Procedural and legal grounds including the validity of DRP directions in light of absence of a valid computer-generated Document Identification Number (DIN), limitation issues, and approval for transfer of matters under section 144B(8).Compliance with rectification directions issued by the DRP regarding exclusion of a particular comparable company from the benchmarking set.2. ISSUE-WISE DETAILED ANALYSISA. Jurisdiction and Procedural Validity of Assessment OrderThe assessee challenged the final assessment order on grounds of jurisdictional invalidity, alleging violation of section 144B and procedural defects such as non-mention of approval for transfer of the case and invalid DRP directions due to absence of a valid computer-generated DIN as per CBDT Circular No. 19 of 2019. The Tribunal noted these grounds but the assessee did not press certain procedural grounds (grounds 1, 2, 18-21) for separate adjudication. However, grounds related to legal issues concerning DRP directions and limitation were kept open pending Supreme Court adjudication in a similar matter. The Tribunal accepted the assessee's request to await the Supreme Court's decision and directed the AO/TPO to follow the outcome in giving effect to this order.B. Transfer Pricing Adjustments - Comparable Companies Selection and Turnover FilterThe primary dispute concerned the selection of comparable companies for benchmarking the international transaction of IT enabled back-office services. The assessee sought exclusion of four companies-Infosys BPM, Inteq BPO, Eclerx, and Tech Mahindra-on the basis that their turnovers were significantly disproportionate compared to the assessee's turnover of approximately Rs. 62.89 crores.The Tribunal examined precedents including its own decisions and those of various High Courts. It reaffirmed the principle that turnover is a relevant factor in determining comparability and that a turnover filter of ten times (both upward and downward) of the assessee's turnover is a valid and reasonable criterion. This approach aligns with the ICAI Transfer Pricing Guidance Note and decisions such as iMedX Information Services (P.) Ltd. Vs. DCIT and Acusis Software India (P) Ltd. Vs. ITO.The Tribunal observed that the turnover of the four companies in question fell outside this tolerance range and thus they could not be considered good comparables. It further noted that the TPO had not applied the turnover filter uniformly to all comparables and remanded the matter to the TPO to apply the turnover filter consistently and conduct a fresh search for comparables.C. Working Capital Adjustment (WCA)The assessee contended that denial of WCA by the TPO was unjustified as detailed working capital cycle data for comparables was unavailable and beyond the assessee's control. The Tribunal referred to Rule 10B(1)(e)(iii) of the Income-tax Rules, 1962, which mandates adjustment of net profit margins to account for material differences between international and comparable uncontrolled transactions.The Tribunal held that differences in working capital levels materially affect profitability and margins. It rejected the TPO's insistence on granular data that is not publicly available and beyond the assessee's reach. The Tribunal directed the TPO to grant WCA based on the average of opening and closing working capital balances as reflected in the comparables' annual reports, consistent with settled principles and judicial precedents.D. Levy of Notional Interest on Trade Receivables - Appropriate Benchmark RateThe TPO made an upward adjustment by levying interest on outstanding trade receivables from AEs at the SBI short term deposit rate. The assessee challenged this, advocating the application of LIBOR plus 200 basis points as the appropriate benchmark rate.The Tribunal examined extensive judicial precedent, including decisions of this Tribunal, Hon'ble Bombay High Court, and Hon'ble Delhi High Court, which consistently held that for international transactions denominated and repaid in foreign currency, the interest rate should be benchmarked against the international market rate applicable to that currency (LIBOR or EURIBOR plus appropriate mark-up), rather than domestic lending or deposit rates.The Tribunal relied on the decision in HARSCO India Private Ltd. v/s DCIT, which emphasized that the currency of the loan determines the arm's length interest rate and that domestic rates like SBI's short term deposit rate or PLR are not appropriate for foreign currency loans or receivables. It further noted the principle that interest rates should be market-determined with respect to the currency concerned, not the country of residence of the parties.Accordingly, the Tribunal directed the AO/TPO to apply LIBOR plus 200 basis points for benchmarking interest on trade receivables from AEs, allowing a normal credit period of 60 days without interest.E. Exclusion of Access Healthcare Services Pvt. Ltd. from Comparable SetThe assessee sought exclusion of Access Healthcare from the comparable set based on a rectification order of the DRP dated 27 January 2023, which found that Access Healthcare failed the export turnover filter and was functionally dissimilar, with no segmental information to support comparability.The Tribunal examined the DRP's rectification order and accepted the direction to exclude Access Healthcare from the comparable set. It accordingly directed the AO/TPO to give effect to this exclusion in the final benchmarking analysis.F. Other Grounds and Legal IssuesSeveral grounds relating to penalty proceedings under section 270A, interest under section 234B, and certain transfer pricing grounds (such as rejection of documentation, inclusion/exclusion of other comparables, and risk adjustment) were not pressed by the assessee and were dismissed accordingly.Grounds concerning the validity of DRP directions due to absence of valid computer-generated DIN, limitation issues, and procedural compliance under section 144B were kept open pending the Supreme Court's decision in a similar case, with directions to the AO/TPO to act accordingly post-decision.3. SIGNIFICANT HOLDINGS'It is well settled by various decisions of co-ordinate benches of ITAT, including in the case of iMedX Information Services (P.) Ltd. Vs. DCIT that the turnover filter of 10 times (both upward and downward) is a valid criteria for determining the comparability.''In terms of Rule 10B(1)(e)(iii) of the Income-tax Rules, 1962, the net profit margin arising in comparable uncontrolled transactions should be adjusted to take into account the differences, if any, between the international transaction and comparable uncontrolled transactions which could materially affect the amount of net profit margin.''The difference in levels of working capital between the tested party and the comparables have an affects on the margins and profitability. Therefore, the Ld. TPO's approach in insisting upon daily/monthly working capital cycle data of third-party comparables is, in our considered view, unjustified, particularly when such data is admittedly not available in the public domain.''Once the transaction between the assessee and the Associated Enterprises is in foreign currency and the transaction is an international transaction, then the transaction would have to be looked upon by applying the commercial principles in regard to international transaction. If this is so, then the domestic prime lending rate would have no applicability and the international rate fixed being LIBOR would come into play.''The interest rate should be the market determined interest rate applicable to the currency concerned in which the loan has to be repaid. Interest rates should not be computed on the basis of interest payable on the currency or legal tender of the place or the country of residence of either party.''The Dispute Resolution Panel-1, Bengaluru had given directions under Section 144C (5) of the Income tax Act, 1961 vide order dated 08.06.2022... Access Healthcare Services Pvt. Limited fails export filter... Functionally dissimilar and lack of segmental information... The TPO is directed to exclude the comparable for the comparability analysis under ITES segment.'Core principles established include:The necessity and validity of applying a turnover filter of ten times in transfer pricing comparability analysis to ensure functional and economic comparability.The legitimacy of granting working capital adjustment based on available data when detailed granular data is not accessible, to neutralize differences affecting profitability.The principle that for international transactions denominated in foreign currency, arm's length interest rates must be benchmarked against international market rates (LIBOR/EURIBOR plus mark-up), not domestic lending or deposit rates.The binding nature of DRP directions including rectifications, mandating compliance such as exclusion of non-comparable entities from benchmarking sets.The prudence of keeping procedural and legal issues open pending authoritative Supreme Court rulings to ensure consistency and judicial discipline.Final determinations:The turnover filter of ten times is upheld as valid and necessary; four specified companies are excluded from comparables.The working capital adjustment is to be granted based on average working capital balances from annual reports.The interest rate for levying notional interest on trade receivables is to be benchmarked at LIBOR plus 200 basis points.Access Healthcare Services Pvt. Ltd. is to be excluded from the comparable set as per DRP rectification directions.Procedural and legal grounds concerning DRP directions and limitation are kept open pending Supreme Court decision.Other non-pressed grounds are dismissed.