2025 (7) TMI 1159 - AT - Income Tax

Transfer pricing comparables selection upheld with turnover filter and functional dissimilarity exclusions validated

ACIT, Circle 3 (3) (1) Versus Xoriant Solutions Private Limited, Mumbai

ITAT Mumbai upheld CIT(A)'s decision on transfer pricing comparable selection criteria. The tribunal accepted exclusion of six companies (including ... TP Adjustment - comparable selection - criteria of comparable companies having turnover between 1/10th to 10 times turnover of the assessee - HELD THAT:- Exclusion of companies as functionally dissimilar with that of assessee. Observations and findings of CIT(A) for each of the comparable companies which have been corroborated by the ld. Counsel of the assessee with the material placed on record in the paper book. The observations and findings of ld. CIT(A) for each of the comparable companies claimed to be excluded for ALP benchmarking is acceptable. [Acropetal Technologies Ltd.,E-Zest Solution Limited, SankhyaInfotech Limited, SankhyaInfotech Limited., E-infochip Ltd, and Thirdware Solutions Limited] Turnover filter - In the first appeal, it is observed by the ld. CIT(A) that although prima facie, turnover should not have a significant impact on profitability in a service-oriented industry, it is an acknowledged fact that the companies acquire significant intangibles in the form of brand and marketing etc. as their turnover increases. In many decisions, a reasonable cap on turnover has been upheld by ITAT of up to 10 times the turnover. Following such guidance, a higher turnover filter of Rs. 380 crore is considered by the ld. CIT(A) as fit for determining the arms’ length price of the international transactions undertaken by the assessee. The factual position stated above is uncontroverted. Akshay Software Technologies Limited, Celstream Technologies Pvt Limited, Evoke Technologies Pvt Limited, Evoke Technologies Pvt Limited, Evoke Technologies Pvt Limited, Kireeti Soft Technologies Limited and Kireeti Soft Technologies Limited be included. ISSUES: Whether exclusion of certain companies from the list of comparables on account of turnover filter is justified in transfer pricing analysis under the Income-tax Act, 1961.Whether turnover differences significantly impact profitability in the context of captive service providers to associated enterprises.Whether exclusion of comparables on the basis of differences in functions, assets, and risks (FAR analysis) is appropriate for benchmarking under the Transactional Net Margin Method (TNMM).Whether segmental margins or partial business activities of comparables should be considered instead of outright exclusion.Whether extraordinary events such as mergers or acquisitions justify exclusion of comparables without detailed financial impact analysis.Whether strict functional comparability is required under TNMM or if minor differences can be disregarded.Whether intellectual property ownership differences affect the selection of comparables in TNMM benchmarking. RULINGS / HOLDINGS: The Court upheld the exclusion of comparables whose turnover was not within the range of one-tenth to ten times the turnover of the assessee, recognizing the turnover filter as a valid criterion in transfer pricing analysis, stating that 'a reasonable cap on turnover has been upheld by ITAT of up to 10 times the turnover.'The Court found that turnover differences may impact profitability due to acquisition of intangibles such as brand and marketing, and therefore turnover filters are relevant even for captive service providers, rejecting the argument that turnover does not affect profit margins in such cases.The exclusion of comparables based on differences in functions, assets, and risks was affirmed after detailed FAR analysis, with the Court agreeing with the appellate authority's fact-based findings that certain companies were functionally different and thus not comparable under TNMM.The Court rejected the contention that segmental margins or partial business activities should be considered instead of exclusion, holding that lack of detailed segmental data and mixed business models justify exclusion of such comparables.The Court accepted exclusion of comparables on grounds of extraordinary events like mergers or acquisitions without requiring detailed financial impact analysis, relying on the appellate authority's discretion and findings.The Court confirmed that under TNMM, strict functional comparability is required and minute differences in functioning can justify exclusion of comparables, consistent with accepted transfer pricing principles.The Court held that intellectual property ownership differences are relevant in excluding comparables, particularly where the comparable owns proprietary rights and the assessee is a captive entity, aligning with TNMM requirements that captive entities should not be selected as comparables. RATIONALE: The Court applied the statutory framework under Sections 92CA(1), 143(3), and 144C(3) of the Income-tax Act, 1961, relating to determination of arm's length price and transfer pricing adjustments.Judicial precedents, including decisions of the jurisdictional High Court and coordinate benches of the ITAT, were relied upon to validate the turnover filter and functional comparability criteria, notably the principles laid down in CIT vs. Pentair Water India (P) Ltd. and various ITAT decisions.The Court emphasized that turnover filters serve as a proxy for size and scale differences which may affect profitability due to intangible assets, thereby justifying their application in transfer pricing comparability analysis.The Court endorsed a fact-based, detailed FAR analysis as essential for comparability determination under TNMM, rejecting mechanical or purely quantitative approaches without qualitative functional assessment.The reasoning reflects no doctrinal shift but reinforces established transfer pricing principles requiring comparables to be similar in functions, assets, risks, and size to the tested party.No dissenting or differing opinions were recorded; the Court's decision aligns with prevailing transfer pricing jurisprudence emphasizing the importance of both quantitative filters and qualitative functional analysis.