2025 (9) TMI 446 - AT - Income Tax

Exclude non-comparable large ITES firms from transfer pricing comparables and recompute ALP shortfall; allow loss set-off

ITAT, BANGALORE (AT) held that two giant ITES companies with turnover vastly exceeding the assessee are not comparable and must be excluded from TP ... TP adjustment - invocation of provisions of section 92C - comparable selection - Infosys BPM Limited and Tech Mahindra Business Services Ltd. selected by TPO which has turnover more than Rs. 200 crores as against the assessee turnover of Rs. 19.24 crores - whether higher turnover companies are comparable with companies having relatively small turnover? - HELD THAT:- This issue has been considered in PCIT v. Softbrands India Pvt. Ltd. in [2018 (6) TMI 1327 - KARNATAKA HIGH COURT] holding that giant companies cannot be compared with small size companies. As there is no dispute that turnover of these two comparable companies is more than 200 times of the turnover of the assessee company, naturally from the comparability analysis of ITeS services, those should be excluded. Both these companies also have huge brand value as those belong to very large groups, which have different capabilities of influencing customers and getting niche advantage, so, not comparable with the small company like assessee, who provides service to its holding company, does not need any leverage of brand, even if it has. Therefore, also same are excluded. We have also examined the analysis made by the ld. TPO by considering the annual accounts of Wipro, Infosys and TCS limited. The claim of the ld. TPO is that increase in turnover did not impact margins. With respect to Infosys limited it says that with the increase in turnover of the company for the year 2002 to 2022 margins were hovering around 40 % only. In case of Wipro turnover increased from 2002-2022 to 20 times margins have reduced. In case of TCS, turnover of the company increased by 20 times, but margins hovered around 38%. Thus, we direct the ld. TPO to exclude the above 2 companies and then compute the shortfall. Rejection of Scionspire Consulting Services (India) Pvt Ltd, iSN Global Solutions Pvt. Ltd and MAA Business Solutions Pvt Ltd by TPO on the grounds that this company does not figure in the search matrix of the TPO - It is not correct to include the comparable which was not part of search matrix of the ld. TPO. Naturally, that amounts to cherry picking. It was also not shown before us that in the Accept/Reject matrix of the TPO at any point of search step this company was included. Accordingly, we find no infirmity in the direction of the ld. DRP in exclusion of the above company. Similarly with respect to MAA Business Solutions Pvt. Ltd., this company was also not part of search matrix of TPO, and it was not shown that at any point of search process this company was falling into Accept/Reject matrix of the TPO. Accordingly, we find no infirmity in the direction of the ld. DRP and action of the ld. TPO in not including the above company. Exclusion of Savitriya Technologies Pvt. Ltd. - No infirmity in the order of the ld. TPO in not excluding Savitriya Technologies Pvt. Ltd. from the comparability analysis. This fact is also evident from the Operating Profit margins of the comparable company which was 26.66%, 35.55% and 20.11% for the 3 years comparable data. For this year it is 26.66 % compared to 35.55 % in earlier year, this has decreased the margin. Merger of entities carrying similar business does not impact the margins but the different business merged may distort margin for that year. It is not shown that there is merger of two heterogenous activity carrying entities. Before us also, assessee could not show any extra-ordinary event of merger impacting the margins, hence we find no reason to exclude the above company. Not given set off of the current year losses - We have heard the parties and examined the computation sheet which started computing income from the adjustments of ALP as business income and it did not consider the losses. Ld. AO is directed to verify the same and grant its set off in accordance with the law. ISSUES PRESENTED AND CONSIDERED 1. Whether companies with substantially larger turnover and significant brand value are comparable for transfer pricing purposes with a small captive ITeS service provider, and whether an upper turnover filter is required in comparability analysis. 2. Whether a comparable that does not appear in the TPO's search matrix or accept/reject steps can be inserted by the taxpayer's TPSR without amounting to cherry picking. 3. Whether an extraordinary corporate event (merger) affecting a comparable during the year under consideration rendered that comparable non-comparable on account of distortion of operating margins. 4. Whether current year losses must be set off against transfer-pricing adjustments computed as business income in the assessment computation. ISSUE-WISE DETAILED ANALYSIS Issue 1 - Comparability of large-turnover, brand-rich companies with a small captive ITeS provider; need for upper turnover filter. Legal framework: Transfer pricing comparability requires consideration of both quantitative and qualitative criteria (size in sales, assets, employees; product portfolios; business strategies). The arm's length principle is to mirror how independent parties would price transactions, which implies broadly similar economies of scale and competitive position between tested party and comparables. Application of appropriate filters is a recognized part of comparability analysis in TNMM benchmarking. Precedent treatment: The Tribunal referred to judicial pronouncements accepting exclusion of giant companies when turnover is multiple times that of the tested entity and recognized coordinate bench decisions and high court authority holding that giant companies cannot be compared with small entities for transfer pricing comparability. Interpretation and reasoning: The Tribunal examined the factual disparity - tested entity turnover about Rs. 11-19 crores versus comparables with turnovers in thousands of crores and strong brand groups - and reasoned that large turnover and brand advantages materially affect market position, bargaining power and ability to sustain different margins. The Tribunal observed that economy of scale effects and market share differences may permit larger players to sell larger volumes at strained margins or potentially earn different operating profit levels; empirical trend tables relied on by the TPO did not meaningfully disprove turnover impact because year-to-year margin variation was wide and the TPO's block-year averaging ignored volatility. The Tribunal also referenced OECD guidance that size criteria are commonly used and that filters must be tailored to the tested entity's facts; guidance note rationale supports use of upper turnover cut-offs to maintain a manageable, broadly similar comparable set. Ratio vs. Obiter: Ratio - the Tribunal's finding that comparables whose turnover is several hundred times that of a small captive ITeS provider and which belong to large branded groups are not comparable is a dispositive holding applied to exclude the two large group comparables. Obiter - general observations on the role of brand value and empirical studies supporting turnover filters are supportive reasoning but ancillary to the holding. Conclusion: The Tribunal directed exclusion of the two giant, brand-rich companies from the comparable set and remitted computation of the shortfall excluding those comparables. Ground challenging inclusion of these companies is allowed. Issue 2 - Inclusion of comparables not in the TPO's search matrix; whether such inclusion amounts to cherry picking. Legal framework: Transfer pricing benchmarking requires a documented search matrix and sequential application of filters (accept/reject matrix). Deviating from the TPO's search matrix by inserting comparables outside the documented search steps undermines the integrity of the arm's length determination and risks cherry picking. Precedent treatment: The DRP and Tribunal treated established procedure of fresh search by the TPO as determinative where the taxpayer's TPSR was rejected; insertion of comparables not in the TPO's search matrix was viewed as impermissible cherry picking. Interpretation and reasoning: The Tribunal noted the TPO carried out a fresh search using accepted databases and search keywords; the taxpayer did not show that the proposed comparables ever appeared in the TPO's accept/reject matrix or were eliminated at a particular step. Allowing insertion would require recollecting other like comparables and would vitiate the methodology. The Tribunal held that the taxpayer's mere assertion of functional similarity without demonstrating presence in the search process is insufficient to override the TPO's methodology and would amount to cherry picking. Ratio vs. Obiter: Ratio - Comparable entities not present in the TPO's search matrix or accept/reject process cannot be unilaterally inserted by the taxpayer where the TPSR was rejected and a fresh TPO search was conducted; such insertion is cherry picking and will not be permitted. Obiter - remarks on potential consequences of permitting ad hoc insertions and on the integrity of the documented search methodology. Conclusion: The Tribunal upheld exclusion of the taxpayer-proposed comparables that did not appear in the TPO's search matrix; inclusion claims are rejected. Issue 3 - Effect of merger as an extraordinary event on comparability of a selected comparable (Savitriya); whether merger distorted margins. Legal framework: An extraordinary event affecting a comparable may justify exclusion if it alters the business profile or financials in a way that renders the comparable functionally or economically dissimilar for the period under consideration. The burden is on the taxpayer to demonstrate such distortion. Precedent treatment: The Tribunal applied the principle that mergers of entities carrying similar business do not automatically amount to extraordinary events that distort margins; heterogenous mergers that materially change business mix could, but must be shown. Interpretation and reasoning: The Tribunal reviewed the merger note and the operating profit margins for the comparable across three years (showing variations but not a pattern indicating distortion attributable to a heterogenous merger). The taxpayer failed to demonstrate that the amalgamated entity engaged in a different business mix that would distort margins. Consequently the Tribunal found no basis to exclude the comparable on this ground. Ratio vs. Obiter: Ratio - Absent evidence that a merger combined heterogenous activities that materially distorted margins, a merger alone is not a ground for exclusion. Obiter - commentary that only mergers changing business character and margins would justify exclusion. Conclusion: The comparable was properly retained; challenge to its inclusion is dismissed. Issue 4 - Set-off of current year losses against transfer-pricing adjustment treated as business income. Legal framework: Adjustments to income pursuant to transfer pricing (ALP adjustments) are to be included in computing total income; set-off of current year losses is governed by statutory provisions and must be properly reflected in the assessment computation to determine tax liability. Precedent treatment: Routine administrative/computational obligation on the Assessing Officer to give effect to allowable set-offs and deductions in accordance with law when computing tax following adjustments. Interpretation and reasoning: The Tribunal observed the assessment computation treated the ALP adjustment as business income but did not consider the returned current year loss of substantial amount. The Assessing Officer was directed to verify and grant the set off in accordance with law. Ratio vs. Obiter: Ratio - The Assessing Officer must consider and give effect to current year losses when computing tax after transfer pricing adjustments; failure to do so requires rectification. Obiter - none. Conclusion: Ground on non-set-off of current year losses is allowed; the AO is directed to verify and grant set-off as per law. Overall Disposition The appeal is partly allowed: (a) two very large branded comparables are excluded and the ALP shortfall is to be recomputed without them; (b) taxpayer's proposed comparables that did not appear in the TPO search matrix are not admitted (cherry picking); (c) exclusion based on merger not sustained for the comparable examined; (d) assessment computation must give effect to current year losses as per law.