Upper Turnover Filter Not Mandatory in Transfer Pricing; Interest Adjustments Disallowed on Next Year's Receivables

The ITAT Bangalore held that applying an upper turnover filter in transfer pricing comparability analysis is not mandatory and depends on case facts, as turnover disparities affect comparability due to economies of scale. The tribunal directed exclusion of a comparable lacking requisite export turnover per the 75% export filter. Additionally, the ITAT disallowed interest adjustments on outstanding receivables from associated enterprises where payment due dates fell in the subsequent financial year, instructing the AO/TPO to delete such adjustments.

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ISSUES:

Whether an upper turnover filter should be applied in transfer pricing comparability analysis for software development services.Whether certain comparable companies included in the benchmarking analysis are functionally dissimilar or fail export turnover filters.Whether imputing interest on overdue trade receivables from associated enterprises constitutes a separate international transaction requiring adjustment under transfer pricing provisions.Whether the rate of interest applied on overdue receivables (Prime Lending Rate of SBI) is appropriate for transfer pricing adjustment.Whether delay in receipt of payments falling in subsequent financial years justifies imputation of interest in the relevant assessment year.

RULINGS / HOLDINGS:

The Court held that the upper turnover filter is "necessarily required to be employed for better determination of arm's-length price" in transfer pricing analysis, especially to exclude comparable companies with turnover multiple times that of the tested entity.The Court directed exclusion of nine comparable companies from the benchmarking analysis as they exceed the upper turnover filter of Rs. 200 crores, following prior coordinate bench decisions and relevant judicial precedents.The Court found that a comparable company with "100% domestic turnover" and "no export turnover" fails the 75% export turnover filter and must be excluded from comparability analysis.The Court ruled that imputing interest on overdue trade receivables from associated enterprises is not justified when the delay in receipt falls in the subsequent financial year, and thus the adjustment of Rs. 693,923/- should be deleted.The Court rejected the application of interest on overdue receivables for invoices where the due date of payment is after the end of the relevant financial year, holding that no adjustment can be made in that year.

RATIONALE:

The Court applied the transfer pricing provisions under sections 92CA and related provisions of the Income-tax Act, 1961, and relied on the OECD Transfer Pricing Guidelines (2022), ICAI Transfer Pricing Guidance Note, and relevant judicial precedents emphasizing the importance of both quantitative and qualitative criteria in selecting comparables.The Court recognized that "economies of scale" and "size criteria in terms of Sales, Assets or Number of Employees" affect comparability, and that turnover disparities materially affect profitability and competitive positions, thus necessitating turnover filters.The Court distinguished the present case from the cited Delhi High Court decision (Chris Capital) by noting that the issue there related to "super normal profits" and not the applicability of turnover filters.The Court emphasized that the arm's-length price should reflect how independent parties price transactions, implying comparability in size and scale is essential.Regarding interest on overdue receivables, the Court noted that such receivables arise in the normal course of business and do not constitute separate international transactions warranting interest imputation when payment delays extend beyond the relevant assessment year.

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