Assessee wins appeal as five companies excluded from transfer pricing comparables list for software development services

ITAT Pune allowed the assessee's appeal regarding transfer pricing comparable selection. The Tribunal excluded four companies - Cybage Software Pvt. Ltd., Nihilent Ltd., Infobeans Technologies Ltd., and E-Infochips Pvt. Ltd. - from the comparables list, consistent with previous decisions for assessment years 2014-15, 2016-17, and 2017-18. Additionally, Ninestars Information Technologies Ltd. was excluded following the precedent in Persistent Systems Ltd. case, where similar software development activities were deemed incomparable. The Assessing Officer/Transfer Pricing Officer was directed to exclude all five companies from determining arm's length price for international transactions with associated enterprises.

---

---

The core legal issues considered by the Tribunal pertain to the determination of the arm's length price (ALP) of international transactions under the transfer pricing provisions of the Income-tax Act, 1961. Specifically, the Tribunal examined whether certain companies included as comparables by the Assessing Officer (AO) and Transfer Pricing Officer (TPO) were functionally comparable to the assessee for the purpose of calculating ALP, and whether the filters and adjustments applied by the AO/TPO in selecting comparables and computing profit level indicators (PLI) were appropriate and justified.

Key issues identified include:

• Whether the AO/TPO erred in modifying or imposing additional quantitative filters on the set of comparables selected by the assessee in its Transfer Pricing Study Report (TPSR).
• Whether the AO/TPO erred in including companies that are functionally dissimilar and excluding companies that are functionally similar to the assessee as comparables.
• Whether the computation of profit margins and application of working capital and risk adjustments by the AO/TPO were correct.
• Whether reliance on company websites and financial statements for determining comparability is permissible.
• Whether the assessee was denied the opportunity of being heard due to lack of disclosure of computations and filter applications.
• Whether the levy of penalty under section 270A for under-reporting of income was justified.

Among these, the principal issue that survived for adjudication before the Tribunal was the exclusion or inclusion of five specific companies as comparables for the calculation of ALP.

Issue-wise Detailed Analysis

1. Modification and Application of Quantitative Filters in Comparable Selection

The assessee challenged the AO/TPO's modification of the quantitative filters originally applied by it, including filters related to income from services as a percentage of operating revenue, employee cost ratios, turnover limits, export turnover ratios, gross intangible assets, accounting year alignment, foreign expenditure, revenue trends, and receivables ratios. The assessee contended that these modifications were arbitrary and resulted in the rejection of companies that should have been considered comparable.

The Tribunal noted that while the assessee raised these grounds, the effective surviving grievance at the hearing was limited to the exclusion of certain comparables. The Tribunal did not delve extensively into the validity of each filter modification but implicitly recognized that the selection and rejection of comparables must be based on functional similarity and relevant criteria.

2. Functional Comparability of Selected Companies

The core dispute centered on whether five companies-Cybage Software Pvt. Ltd., Nihilent Ltd., Infobeans Technologies Ltd., E-Infochips Pvt. Ltd., and Ninestars Information Technologies Ltd.-were functionally comparable to the assessee, which is engaged in software development and support services for its associated enterprises.

The legal framework governing transfer pricing requires that comparables should be functionally similar, i.e., they should perform similar functions, bear similar risks, and employ comparable assets. The Tribunal examined prior decisions of the same Tribunal in the assessee's own cases for earlier assessment years, where these companies had been consistently found functionally dissimilar and excluded from the comparable set.

Specifically, the Tribunal relied on precedents wherein the above four companies (excluding Ninestars) were excluded after detailed functional analysis. The Tribunal emphasized the principle of consistency, holding that the same companies could not be included as comparables in the instant year when they were excluded in preceding years on similar grounds.

Regarding Ninestars Information Technologies Ltd., the Tribunal referred to a recent decision in the case of another company engaged in software development, where Ninestars was held functionally dissimilar because it primarily provided content services, analytical services, and software consultancy, which differed from the software development and support services offered by the assessee.

The Tribunal scrutinized the Annual Report and found the description of Ninestars' business activities cryptic and insufficient to establish functional similarity. Consequently, it held Ninestars not functionally comparable and directed its exclusion.

3. Computation of Profit Level Indicator and Adjustments

The assessee contended that the AO/TPO erred in computing margins of comparables, applying working capital adjustments without proper documentation, and denying risk adjustments despite differences in risk profiles. The Tribunal did not provide an elaborate discussion on these points, as the primary issue was the inclusion of inappropriate comparables. However, the directions to exclude the identified comparables implied that subsequent re-computation of median PLI and ALP would be undertaken by the AO/TPO, presumably addressing these concerns.

4. Reliance on Company Websites and Financial Statements

The assessee argued that reliance on company websites for functional analysis was legitimate. The AO/TPO had rejected this reliance. The Tribunal did not explicitly rule on this issue but implicitly accepted the use of financial statements and annual reports as valid sources for functional comparability assessment, as evidenced by its reliance on such documents in evaluating Ninestars.

5. Opportunity of Being Heard

The assessee claimed denial of opportunity of being heard due to non-disclosure of computations related to filters and adjustments. The Tribunal did not specifically address this grievance but by allowing the appeal and directing re-computation, it remedied any procedural prejudice.

6. Levy of Penalty under Section 270A

The assessee challenged the issuance of penalty notices for under-reporting of income. The Tribunal did not discuss this issue in detail, indicating that it was not a decisive factor in the appeal's outcome.

Significant Holdings

The Tribunal held that the five companies included by the AO/TPO as comparables were functionally dissimilar to the assessee and therefore must be excluded from the comparable set for determining the ALP of international transactions. The Tribunal stated:

"We therefore direct the Assessing Officer/Transfer Pricing Officer to exclude all these four comparable companies namely (1) Cybage Software Pvt. Pvt. Ltd. (2) Nihilent Ltd. (3) Infobeans Technologies Ltd. and (4) E-Infochips Pvt. Ltd. from the list of comparables."

"...we hold that Ninestars Information Technologies Ltd. is not a good comparable and deserves to be excluded from the list of comparables. We direct the Assessing Officer/Transfer Pricing Officer to exclude the said company from the list of comparables."

The Tribunal emphasized the principle of consistency by relying on its earlier decisions in the assessee's own cases and underscored the necessity of functional similarity in transfer pricing comparability analysis.

The final determination was that all five disputed comparables are to be excluded, and the AO/TPO was directed to recompute the median PLI and ALP accordingly. The appeal was allowed on these grounds.

---