2025 (8) TMI 1528 - HC - Income Tax

Rejection of two transfer pricing comparables upheld; segment financials can't bypass 75% revenue filter for ALP, no substantial question found

HC upheld the appellate authority's rejection of two comparables used in a TP study, agreeing that segment financials cannot be used to bypass the ... TP Adjustment - comparable selection - Universal Print System Ltd and BNR Udhyog Ltd. - Assessee had objected to the inclusion of the said two comparables on the ground that the two entities were not comparable on the basis of their FAR profile HELD THAT:- In cases where the financials of the relevant segment are available and can be authenticated, there would be no difficulty in determining the ALP on the basis of financials of the given segment. However, in the present case, the issue is not whether financials for a particular segment can be adopted. CIT (A), had faulted the selection of comparables on the basis of the filter adopted. Thus, if the revenues of the comparable segment is less than 75% of the total revenue of the entity, the same could not be selected for purpose of the transfer pricing study on the basis of the selected filter. It would be not open to look into the financials of the segment for overcoming the filter as adopted. No infirmity with the said view. No substantial question of law arises. ISSUES PRESENTED AND CONSIDERED 1. Whether the Tribunal erred in excluding two entities from the comparable set for transfer pricing analysis by failing to account for availability of segmental financials and thereby wrongly determining service revenue for the purpose of applying the 75% service revenue filter. 2. Whether the Tribunal erred in applying the service revenue filter at the entity level rather than permitting application at the segment level where segmental financials for the comparables were available. ISSUE-WISE DETAILED ANALYSIS Issue 1 - Exclusion of comparables based on the 75% service revenue filter Legal framework: The transfer pricing analysis pursuant to Section 92CA and related provisions requires selection of comparable companies using appropriate filters (including a service revenue filter of 75% for entities whose main source of income is software development/ITeS). The Transactional Net Margin Method (TNMM) requires comparability assessment based on FAR (Functional, Asset and Risk) profile and selection filters to ensure appropriate arm's length pricing. Precedent treatment: The judgment treats the role of the TPO's filters and the CIT(A)'s scrutiny of their correct application; it accepts that segmental financials may, in appropriate cases, be used where available and authenticated, but does not cite or disturb any specific precedent. Interpretation and reasoning: The Court accepted the CIT(A)'s finding that the TPO applied the 75% service revenue filter at the segment level for the two impugned entities (by isolating their BPO/ITeS segments), whereas the filter as formulated and applied in the comparability exercise was intended to operate at the entity level. The CIT(A) demonstrated that when total entity-level revenues are considered, both entities fail the 75% threshold (21.63% and 42.92% respectively). The Tribunal affirmed the CIT(A)'s categorical finding and noted absence of dispute from the Revenue before the Tribunal on this factual finding. Ratio vs. Obiter: Ratio - It is the correct approach that where a selection filter is stated and applied at entity level, comparables that do not meet that entity-level filter must be excluded even if a qualifying percentage appears in a discrete segment; the Tribunal's endorsement of the CIT(A)'s exclusion is binding for the appeal's scope. Obiter - The general proposition that segmental financials may be used where available is an explanatory remark rather than the basis of the decision. Conclusions: The Court concluded there was no infirmity in the CIT(A)'s determination that the two companies failed the 75% service revenue filter when applied at the entity level, and therefore their exclusion from the comparable set was justified. No substantial question of law arose from this factual and application-based conclusion. Issue 2 - Use of segmental financials to overcome entity-level filter Legal framework: Transfer pricing rules permit use of most reliable and relevant financial information to determine Arm's Length Price, including segmental results where properly available and authenticated; however, selection criteria/filters used in comparability must be consistently applied. Precedent treatment: The Court recognized the uncontroversial proposition that segmental accounts may be resorted to when available and verifiable, but it distinguished the present case on the basis of how the filter was framed and applied by the TPO and assessed by the CIT(A) and Tribunal. Interpretation and reasoning: The Court held that although segmental financials can be adopted in cases where such financials are available and can be authenticated, that principle cannot be used to override or subvert a prescribed filter that was intended to be applied at the entity level. The TPO's adoption of segment-level revenue for applying the 75% service revenue criterion effectively altered the agreed filter and thereby improperly retained as comparables entities that, at the entity level, do not qualify. Consequently, it was impermissible to 'look into' the segmental financials to overcome the entity-level exclusion prescribed by the filter. Ratio vs. Obiter: Ratio - Where a comparability filter is articulated and applied at the entity level, availability of segmental financials does not permit selective application at segment level to circumvent the entity-level filter; comparables failing the entity-level filter must be excluded. Obiter - The general permissibility of using segmental financials when authenticated remains true but is subordinate to consistency in application of selection criteria. Conclusions: The Court found no error in the Tribunal's endorsement of the CIT(A)'s approach; segmental financials could not be used to retain entities that fail the entity-level 75% service revenue filter. The Revenue's contention that ALP should be determined on segment financials where available was acknowledged as correct in principle but not applicable to allow overcoming a filter expressly applied at entity level in this case. Cross-reference Issues 1 and 2 are interrelated: the factual application of the 75% service revenue filter (Issue 1) determined whether segmental financials could be used to preserve comparability (Issue 2). The Court's reasoning ties the permissibility of segment-level analysis to consistent application of the pre-specified filters; because the filters were to be applied at the entity level, segmental results could not cure non-compliance. Disposition The appeal was dismissed on the ground that the CIT(A) and Tribunal correctly excluded the two entities from the comparable set for failing the 75% entity-level service revenue filter; no substantial question of law arises for consideration.