2025 (10) TMI 902 - AT - Income Tax

Exclude domestic items for operating margin; apply 25% aggregate RPT filter, recompute comparables; revise interest to LIBOR+200bps and SBI PLR

ITAT directed the AO/TPO to exclude domestic revenue and expenditure when computing operating margin for international ITES transactions and to recompute ... TP Adjustment - whether the domestic revenue and expenditure should be excluded while computing the operating margin for determination of ALP in respect of international transactions relating to provision of ITES? - HELD THAT:- On perusal of the order of the TPO, we find that no specific reasoning has been given while including domestic revenue and expenditure. Similarly, the Ld. DRP has also not rendered any finding, except stating that the approach adopted by the Ld. TPO is appropriate. We find merit in the submissions of the AR that ALP is to be determined with reference to international transactions alone. In our considered view, the domestic transactions are not to be mixed with international transactions for computing operating margins. Inclusion of domestic revenue and expenditure results in distortion of the profitability from international transactions, thereby vitiating the comparability analysis. Accordingly, we direct the Ld. AO/TPO to recompute the operating margin of the assessee after excluding domestic revenue and domestic expenditure, and thereafter determine the ALP afresh. Working of related Party Transaction ('RPT') Filter - AR submitted that the assessee in its Transfer Pricing ('TP') study applied a 25% RPT filter, whereby any company having aggregate related party transactions in excess of 25% of sales was rejected as a comparable - whether the RPT filter should be computed on aggregate basis or separately for revenue and expenditure? - HELD THAT:- It is not disputed that, in the assessee's own case for AYs 2017-18 and 2018-19, the Ld. TPO had applied the aggregate method of computation of RPT filter. In the year under consideration, however, without assigning any cogent reason or pointing out any change in facts or law, the TPO has changed the methodology by adopting separate computation for revenue and expenditure. We are of the considered view that in the absence of any change in facts or law, the principle of consistency must be followed. Once the methodology has been accepted in earlier years and there being no distinguishing feature in the present year, the same method should be applied. Tribunal has categorically held that RPT filter should be computed on an aggregate basis. Therefore, respectfully following the same, we direct the Ld. AO/TPO to recompute the RPT filter on aggregate basis across all comparables and thereafter rework the comparability analysis. Comparable selection - exclusion of Infosys BPM Limited, Sutherland Global Services Private Limited, Integra Software Services Private Limited and MPS Limited from the list of comparables - As regards exclusion of Infosys BPM Limited, as directed the Ld. AO/TPO to apply the RPT filter on aggregate basis. If Infosys BPM Limited fails the 25% RPT threshold under the aggregate method, then it cannot be retained as a comparable. Accordingly, we direct the Ld. AO/TPO to exclude Infosys BPM Limited from the list of comparables if it fails the RPT filter. Since we are granting relief on the RPT issue itself, we do not propose to adjudicate separately on the functional comparability argument. Exclusion of Sutherland Global Services Pvt. Ltd., the assessee has claimed that this company fails the RPT filter for AY 2019-20 when computed on aggregate basis. In line with our earlier direction, we direct the Ld. AO/TPO to apply the aggregate method of RPT filter for AY 2019-20, and if Sutherland Global Services Pvt. Ltd. fails the test, its margin for AY 2019-20 shall be excluded while arriving at the average margin of comparables. Exclusion of Integra Software Services Pvt. Ltd. and MPS Limited are not comparable to companies engaged in ITES. We hold that Integra Software Services Pvt. Ltd. and MPS Limited cannot be considered as comparables for the assessee engaged in ITES. Cheers Interactive India Pvt. Ltd. be directed to be included in the set of comparables. Iservices India Pvt. Ltd - Reasoning given by the Ld. TPO for exclusion of Iservices India Pvt. Ltd. on the ground of RPT filter is unsustainable. Once the correct computation is applied, the company passes the RPT test and is functionally comparable to the assessee. Accordingly, we direct the Ld. AO/TPO to include Iservices India Pvt. Ltd. in the final list of comparables, after due verification of figures from the audited accounts. Cheers Interactive India Pvt. Ltd. we agree with the submission of the Ld. AR that the figure of 29.72% adopted by the Ld. TPO is a result of including payments to KMP under RPT expenses, which is not in line with the consistent methodology adopted. Once the correct working is applied, the RPT is well within the 25% threshold, and the company qualifies the RPT filter. Accordingly, we direct the Ld. AO/TPO to include Cheers Interactive India Pvt. Ltd. in the final list of comparables after due verification of the audited figures. Maa Business Solutions Pvt. Ltd. and Virinchi Ltd. assessee has placed on record that both these companies are appearing in the search conducted through the Capitaline database, which is also a recognized source for transfer pricing analysis. In our considered view, exclusion of comparables merely on the ground of 'not appearing in one database' cannot be sustained when they appear in another validly recognized database. What is relevant is whether the company satisfies the functional comparability (FAR) test and filters applied, and not the mere database in which it is traced. Accordingly, we direct the Ld. AO/TPO to carry out a fresh search in the Capitaline database, and if Maa Business Solutions Pvt. Ltd. and Virinchi Ltd. are found therein, the Ld. AO/TPO shall consider their inclusion in the list of comparables after carrying out FAR analysis. Working of Interest on Delayed Receivables - Tribunal in assessee's own case has categorically held that LIBOR plus 200 basis points is the appropriate benchmark for determining arm's length interest on delayed receivables from AEs. Therefore, respectfully following the said decision, we direct the Ld. AO/TPO to recompute the interest on overdue receivables by applying LIBOR + 200 basis points. As regards the assessee's request for adopting a weighted average credit period, we note that this specific plea was considered and rejected by the Tribunal in assessee's own case in AY 2017-18. Therefore, following the same, we reject the request of the assessee for adopting weighted average period. Benchmarking of Interest on CCDs - whether interest payable on CCDs issued by the assessee should be benchmarked with reference to SIBOR or SBI PLR? - We find that the Special Bench of this Tribunal in the assessee's own case for AYs 2015-16 and 2018- 19 [2025 (6) TMI 48 - ITAT HYDERABAD] has categorically held that interest paid or payable on FCCDs/NCDs/other debentures denominated in Indian currency should be benchmarked by applying SBI PLR. In the present case, it is an admitted position that the CCDs issued by the assessee are denominated in Indian currency. Therefore, respectfully following the binding decision of the Special Bench in assessee's own case, we hold that SBI PLR is the appropriate benchmark. Accordingly, we direct the AO/TPO to recompute the arm's length interest on CCDs by applying SBI PLR instead of SIBOR. ISSUES PRESENTED AND CONSIDERED 1. Whether domestic revenue and expenditure should be included when computing the operating margin for determination of Arm's Length Price (ALP) in respect of international transactions for provision of IT-enabled services (ITES). 2. Whether the Related Party Transaction (RPT) filter of 25% must be computed on an aggregate basis (related party income + related party expenditure / total revenue) or separately for revenue and expenditure. 3. Whether specific comparable entities (Infosys BPM Ltd., Sutherland Global Services Pvt. Ltd., Integra Software Services Pvt. Ltd., MPS Ltd., Iservices India Pvt. Ltd., Cheers Interactive (India) Pvt. Ltd., Maa Business Solutions Pvt. Ltd., Virinchi Ltd.) should be included/excluded from the comparable set based on functional comparability, RPT filter results, search-database limitations and prior Tribunal precedents. 4. Whether notional interest on delayed receivables from associated enterprises (AEs) should be benchmarked using domestic short-term deposit/PLR rates or international rates (LIBOR) and whether interest should be computed invoice-wise or by applying weighted average credit period. 5. Whether interest on Compulsory Convertible Debentures (CCDs) denominated in Indian rupees should be benchmarked against a foreign interbank rate (SIBOR/LIBOR) or against domestic prime lending rate (SBI PLR), and whether CCDs ought to be recharacterised as foreign loans for transfer pricing purposes. ISSUE-WISE DETAILED ANALYSIS Issue 1 - Inclusion of Domestic Revenue and Expenditure in Operating Margin Computation Legal framework: ALP determination under transfer pricing principles requires comparability of the international transaction and associated functions, assets and risks; margins used for benchmarking should reflect profitability attributable to the international transaction. Precedent treatment: No specific higher-court precedent furnished by authorities below; Tribunal relied on transfer-pricing principles of transaction-level comparability. Interpretation and reasoning: The Tribunal observed that neither the Transfer Pricing Officer (TPO) nor the Dispute Resolution Panel (DRP) provided cogent reasoning for mixing domestic and international revenues/expenditures. Inclusion of domestic transactions distorts profitability attributable to international ITES services and vitiates comparability analysis. Ratio vs. Obiter: Ratio-The Tribunal treated this reasoning as a binding determination for the appeal (operative direction to recompute), not mere obiter. Conclusion: Domestic revenue and expenditure must be excluded from the operating margin computation for benchmarking international ITES transactions; AO/TPO directed to recompute operating margin and determine ALP afresh after exclusion. Issue 2 - Methodology for Computing RPT Filter (Aggregate v. Separate) Legal framework: RPT filter (25% threshold) is a comparability filter under transfer pricing practice to exclude comparables unduly influenced by related-party transactions; methodology must be consistently applied. Precedent treatment: Tribunal relied on coordinate-bench decisions (Toyota Kirloskar Motor Ltd. and earlier Tribunal orders in the assessee's own cases) holding RPT ratio should be computed on aggregate basis (RPT income + RPT expenses)/sales. Interpretation and reasoning: In absence of any change in facts or law, a change in methodology by the TPO (from aggregate to separate computation) is impermissible as it breaches the principle of consistency. The Tribunal emphasised application of same method as adopted in prior assessment years and coordinate-bench authority. Ratio vs. Obiter: Ratio-Tribunal directed AO/TPO to recalculate RPT filter on aggregate basis for all comparables and rework comparability analysis; binding for the proceedings at hand. Conclusion: RPT filter to be computed on aggregate basis; AO/TPO directed to reapply the filter across comparables and adjust comparable set accordingly. Issue 3 - Inclusion/Exclusion of Specific Comparables Legal framework: Comparable selection requires functional comparability (FAR), and passing of statistical/filters (including RPT); search methodology should be reasonable and may use recognized databases. Precedent treatment: Tribunal relied on its own earlier decisions (including a decision in the assessee's own-related matters and other coordinate-bench rulings) excluding or including particular entities where functional dissimilarity or database/search issues were established. Interpretation and reasoning: - Infosys BPM Ltd. and Sutherland: inclusion contingent on outcome of RPT filter recomputed on aggregate basis; if they fail the aggregate 25% test, they must be excluded. - Integra Software Services Pvt. Ltd. and MPS Ltd.: excluded following prior Tribunal findings that these entities are functionally dissimilar to ITES providers; earlier Tribunal precedent applied. - Iservices India Pvt. Ltd. and Cheers Interactive: exclusion by TPO was factually incorrect; on verification of audited disclosures these entities pass the RPT test on aggregate basis and are functionally comparable; Tribunal directs inclusion after verification. - Maa Business Solutions and Virinchi: exclusion solely because they did not appear in AO/TPO's chosen database (ProWess) is unsustainable where they appear in another recognized database (Capitaline); relevance is FAR and filters, not the particular database used. Ratio vs. Obiter: Mixed-Where the Tribunal set definitive inclusion/exclusion (Integra, MPS excluded; Iservices and Cheers included subject to verification) these are operative ratios for the appeal. Directions to reapply RPT filter and to use recognized databases are procedural ratios applicable to remand. Conclusion: Tribunal directed AO/TPO to (a) exclude comparables failing the aggregate RPT test, (b) exclude Integra and MPS per prior Tribunal precedent, (c) include Iservices and Cheers after verification of audited figures, and (d) undertake fresh search in Capitaline and consider Maa Business Solutions and Virinchi if they satisfy FAR and filters. Issue 4 - Benchmarking Interest on Delayed Receivables from AEs Legal framework: Notional interest on overdue inter-company receivables may be treated as an international transaction under section defining international transactions and must be benchmarked to determine ALP; choice of comparable interest rate must reflect the relevant currency and economic reality of the AE transaction. Precedent treatment: Tribunal followed its own prior decision in the assessee's case for an earlier assessment year which held that LIBOR plus 200 basis points is the appropriate benchmark for interest on foreign-currency trade receivables from non-resident AEs (supported by higher-court reasoning cited therein). Interpretation and reasoning: The Tribunal accepted that receivables denominated in foreign currency reflect benefits/losses measured by internationally recognized rates; SBI short-term deposit rate used by TPO was inappropriate. The Tribunal rejected the assessee's plea for weighted-average credit period because that specific plea had been considered and rejected in the prior Tribunal order. Ratio vs. Obiter: Ratio-Tribunal directed recomputation of interest on overdue receivables by applying LIBOR + 200 basis points; rejection of weighted-average credit period is an operative finding for this appeal following earlier precedent. Conclusion: AO/TPO to recompute notional interest on delayed receivables applying LIBOR + 200 bps; invoice-by-invoice/weighted-average credit-period approach not adopted in favour of prior-trial finding rejecting weighted-average method. Issue 5 - Benchmarking Interest on Rupee-Denominated CCDs and Recharacterisation Legal framework: Benchmarking of interest on related-party debt instruments must consider the currency of denomination and comparable domestic/foreign rates; characterization of CCDs (debt v. equity) for transfer pricing benchmarking depends on their economic nature and currency. Precedent treatment: Tribunal followed a binding Special Bench decision in the assessee's own matters holding that interest on CCDs/NCDs/other debentures denominated in Indian currency should be benchmarked using domestic PLR (SBI PLR) rather than foreign interbank rates (LIBOR/SIBOR). Interpretation and reasoning: Since CCDs in issue are rupee-denominated, treating them as foreign currency loans for benchmarking is inappropriate. The Special Bench's ratio-that rupee-denominated convertible instruments are to be benchmarked against domestic lending rates-was held binding and directly applicable. The Tribunal therefore did not accept recharacterisation as foreign loan for benchmarking purposes and applied the Special Bench ratio. Ratio vs. Obiter: Ratio-Binding; the Tribunal directed recomputation of ALP interest on CCDs by applying SBI PLR instead of SIBOR/LIBOR. Conclusion: CCDs denominated in Indian currency to be benchmarked using SBI PLR; AO/TPO directed to recompute arm's length interest accordingly. Recharacterisation as foreign loan for benchmarking disallowed in this context. Overall Disposition The appeal was partly allowed for statistical purposes: the Tribunal (i) directed exclusion of domestic revenue/expenditure from operating margin computation, (ii) ordered RPT filter to be computed on aggregate basis and rework of comparability, (iii) directed inclusion/exclusion of specific comparables as per verifications and prior precedents, (iv) directed recomputation of interest on delayed receivables using LIBOR + 200 bps, and (v) directed recomputation of interest on rupee-denominated CCDs using SBI PLR. These directions are operative for remand to the AO/TPO for fresh computation consistent with the findings.