TaxTMI 
TaxTMI 
2015 (4) TMI 949
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....aking companies' data in the list of "comparables"? Benches of Income Tax Appellate Tribunal ("ITAT"), appear to be riven in their opinion on this; it is the subject matter of the present appeal. 2. The questions framed for decision in this appeal, under Section 260-A of the Act, arising from an order of the Income Tax Appellate Tribunal ("ITAT") dated 20.12.2013 in ITA No. 6183/Del/2012 for assessment year (AY) 2008-09, are as follows: 1) Whether the proviso to Rule 10B(4) of the Income Tax Rules, 1962 will be applicable in case of fluctuations in the operating profit margins of comparable companies during the relevant financial year under question as compared to earlier years? 2) Whether comparables can be rejected on the ground that they have exceptionally high profit margins as compared to the assessee in transfer pricing analysis? 3) Whether factors like differential functional and risk profile coupled with high degree of volatility in operating profit margins is sufficient ground to reject comparables for transfer pricing analysis? 4) Whether disallowances can be made under Section 36(1)(ii) when the bonus paid to shareholders is not in ....
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....ternational transaction or a specified domestic transaction shall be the data relating to the financial year in which the international transaction or the specified domestic transaction has been entered into: Provided that data relating to a period not being more than two years prior to such financial year may also be considered if such data reveals facts which could have an influence on the determination of transfer prices in relation to the transactions being compared." The assessee argued that using multiple year data is consistent with the OECD Guidelines as well as transfer pricing regulations of several developed jurisdictions. The Operating Margin of the assessee was stable in contrast to the comparable companies, described below: Financial Year Operating Margin 2005-06 24.15% 2006-07 21.14% 2007-08 27.05% Average 24.11% 5. On 30.09.2008, the assessee filed its return for AY 2008-09 declaring a total income of Rs. 12,41,83,160. Its case was scrutinized by the AO who referred the matter to the Transfer Pricing Officer ("TPO") under Section 92CA (3) of the Act. On 03.10.2011, the TPO passed an order recommending transfer pricing add....
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.... and rejected three other comparables selected by the assessee (i.e. IDFC Investment Advisors Ltd. (17.35%), Sumedha Fiscal Services Limited (9.14%) and Future Capital Holdings Limited (20.56%). Khandwala had been selected as a comparable by the assessee itself based on the multiple year data for the comparability analysis. However, the TPO substituted the same with the data for the concerned financial year, in which Khandwala had exceptionally high profit margins. The ITAT upheld these findings and held that current year data should be used in the absence of abnormal or exceptional facts/circumstances in existence which could have an influence on the results as well as the determination of the transfer prices for the year under consideration. Further, the ITAT held that Rule 10B does not provide any basis to exclude an entity or eliminate it from the list of companies solely on the basis of high profitability. The authorities - including ITAT, held that the decisive factors for determining inclusion or exclusion of any entity in/from the list of comparables are the specific characteristics of the services provided by the said entities, assets employed, risks assumed, the contractu....
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....ated from the annual report of the year, we do find it may not be a robust comparable. According to the assessee ‗we would like to state that this company has very volatile profit margins and since the Ld. TPO has computed the ALP on the basis of single year data (data for the FY 2005-06 only) this company should not be included in the final set of comparable as it would lead to distortion of the ALP.' The assessee while determining the ALP considered data for three years which mitigated the high volatility in operating margins of this company. However on the basis of single year data the operating margins of this company will substantially inflate the operating margins. "The volatility in the operating margin of this company is clearly evident from the three year profitability of the comparables submitted before you are the Ld. TPO vide submission dated May 18, 2009 (copy enclosed at page 139 of the paper book dated January 01, 2010 filed before the Hon'ble Panel). The operating margin of this company during the FY 2003-04 was negative 6.87% and which converted to positive 13.33. In the FY 2004-05, thereby exhibiting the this margin further increased to 94.....
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....us paid - that no dividend was declared by the assessee - is incorrect as it paid interim dividend amounting to Rs. 5,47,47,000/- in the concerned assessment year. Thus, the bonus paid to the two shareholders was not in lieu of dividend and therefore, should be allowed as tax deductible expenditure. 11. Learned counsel argued that the ALP of an international transaction has to be determined by applying one of the methods provided in section 92-C (3) of the Act; it should be the most appropriate method and should also take into account prescribed factors. This is, counsel stated, elaborated in Rule 10-B of the Rules, which contemplates adjustment on account of functional and other differences. He contended that adopting of any method ultimately envisages comparison of like functions, transactions and enterprises. Rule 10B(2)(a) provides that specific characteristic of services rendered by the two entities should be compared in order to treat the same as comparables for the purpose of transfer pricing analysis. Counsel also referred to the OECD guidelines and argued that accurate ALP determination is dependent on flexibility and sound exercise of discretion. Chapter III of the OEC....
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....er the previous year. This was considered to be too high to be allowed as a comparable. During the current year, the profit registered was 191%. In the circumstances, it was illogical and arbitrary for the revenue to have rejected the contention that data in respect of Keynote should have been excluded. It was also similarly argued that the ITAT fell into error in rejecting the assessee's objection with respect to Brescon whose total turnover was over Rs. 14 crores, of which the comparable business was only Rs. 2 crores; the absence of any sectional data with regard to this company, meant that its activities were not comparable, on a fair application of Rule 10-B (2) and (3). 14. Learned counsel relied on the decisions of the Special Bench in the case of Quark Systems Private Limited v. DCIT (2010 38 SOT 307- Chandigarh Bench) Adobe Systems India Pvt. Ltd. (Del) 2011-(TII)-13-ITAT-DEL); Teva India (P) Ltd v. DCIT, [2011] 44 SOT 105 (Mum); Sapient Corporation (P) Ltd. v. Deputy CIT, [2011] 11 Taxmann 69 (Delhi); Asst CIT vs. Maersk Global Services Centre (India) P. Ltd. (133 ITD 543)(Mum.); Symantec Software Solutions (P) Ltd. v. Assistant CIT [2012] 25 Taxmann 163 (Mum); and....
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....igher profit (than the assessee or a significantly high profit in the industry) or even one making a so called "super profit" too cannot be eliminated. Generally, both loss making units and high profit making units cannot be removed from the list of comparables unless, such removal is statutorily permitted by Rule 10-B (2) or (3). Counsel also submitted that this is also evident from a reading of Rule 10-C. It was pointed out that Rule 10B (3) (ii) and Rule 10 C (2)(e) permitted adjustment to eliminate material defects of the difference between the assessee and comparables. Counsel argued that only those factors which result in material difference in the comparables of transactions as between the assessee and the unrelated transaction or the third party enterprise, have to be reasonably adjusted to avoid distortions under the said provisions. The step envisioned there had to be necessarily followed keeping in view the mandate "shall". 18. It was also argued that the decision in Commissioner Of Income Tax v Mentor Graphics (Noida) Pvt.Ltd (ITA 1114/2008, decided by this court on 04-04-2013) has held that OECD guidelines cannot be applied because there are specific provisions of R....
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....ument relating to an international transaction [or specified domestic transaction] have not been kept and maintained by the assessee in accordance with the provisions contained in sub-section (1) of section 92D and the rules made in this behalf; or (c) the information or data used in computation of the arm's length price is not reliable or correct; or (d) the assessee has failed to furnish, within the specified time, any information or document which he was required to furnish by a notice issued under sub-section (3) of section 92D, the Assessing Officer may proceed to determine the arm's length price in relation to the said international transaction [or specified domestic transaction] in accordance with sub-sections (1) and (2), on the basis of such material or information or document available with him: Provided that an opportunity shall be given by the Assessing Officer by serving a notice calling upon the assessee to show cause, on a date and time to be specified in the notice, why the arm's length price should not be so determined on the basis of material or information or document in the possession of the Assessing Officer." 20. Secti....
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....ices provided in either transaction ; (b) the functions performed, taking into account assets employed or to be employed and the risks assumed, by the respective parties to the transactions ; (c) the contractual terms (whether or not such terms are formal or in writing) of the transactions which lay down explicitly or implicitly how the responsibilities, risks and benefits are to be divided between the respective parties to the transactions ; (d) conditions prevailing in the markets in which the respective parties to the transactions operate, including the geographical location and size of the markets, the laws and the Government orders in force, costs of labour and capital in the markets, overall economic development and level of competition and whether the markets are wholesale or retail. (e) the extent to which reliable and accurate adjustments can be made to account for differences, if any, between the international transaction or the specified domestic transaction and the comparable uncontrolled transaction or between the enterprises entering into such transactions; (f) the nature, extent and reliability of assumptions required to b....
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....tillium India P. Ltd vs. DCIT (2012)(20 ITR 69) (Bang)(Tri.) and Addl CIT vs. Frost and Sullivan India (P) Ltd (supra). The revenue has on the other hand, relied on contrary views in Actis Advisers P. Ltd. v. Deputy CIT [2012] 20 ITR (Trib) 138 (Delhi); 24/7 Customer.Com.Pvt.Ltd. v. Deputy CIT [2013] 21 ITR (Trib) 514 (Bang) and Willis Processing Services (I) P. Ltd. v. Deputy CIT [2014] 30 ITR (Trib) 39 (Mum). Such views are echoed in Trilogy E-Business Software India P. Ltd. v. Deputy CIT [2013] 23 ITR (Trib) 464 (Bang) and Stream International Services P. Ltd. v. Asst. DIT (International Taxation) [2013] 23 ITR (Trib) 70 (Mum) too. 24. Before analysing the relative strengths of the rival contentions, a tabular statement containing the reasoning which persuaded various Benches of the ITAT to conclude one way or the other is reproduced below: S. No. Judgment Finding Rationale 1. ITO v. Saunay Jewels (P) Ltd., [2010] 42 SOT 2 (Mum). 1. One of the four comparables chosen by the TPO (Sovereign Diamonds Ltd.) should be excluded. 2. Simple arithmetic average of gross profit margin cannot be adopted as there is a wide variation in the parameters. Wei....
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.... SREI Caps' core business was merchant banking and consultancy income accounted for only 0.27% of the total income. Absence of segmental data insofar as the investment advisory service provided by the assessee is concerned led to the exclusion of comparables. 7. Deputy CIT v. Deloitte Consulting India Pvt. Ltd., ITA No. 1082/Hyd/2010 dated 22/07/2011 Inclusion of Vishal Information Technology Limited as a comparable was not incorrect. Wipro cannot be a comparable. Assessee derived its income from software development and IT enabled services. Assessee itself argued before the TPO that VTIL is a comparable company offering IT enabled services. The intangibles will not Previous year data can be used for comparables only under exceptional circumstances. materially affect the price or profit-earning [within the meaning of Rule 10B(3)]. No two comparable companies can be replicas of each other. Rule 10B should be applied on a broader perspective and not with technical rigour. Wipro cannot be a comparable as its turnover is 20 times that of the assessee. 8. Symantec Software Solutions (P) Ltd. v. Assistant CIT, [2012] 25 Taxmann 163 (Mum). Two entities ....
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.... earning supernormal profits. Extreme cases should be avoided while making a comparative study of analogous cases. 13. Exxon Mobil Company India P. Ltd. v. Deputy CIT [2012] 15 ITR (Trib) 353 (Mum) Rejected the assessee's contention that two loss making concerns had to be included among comparables. As regards exclusion of entities earning abnormal profits, a general submission cannot be accepted; the assessee should bring out the peculiar features why such exclusion is necessary in the circumstances of the case. 14. Maersk Global Centres (India) (P) Ltd. v. ACIT, [2014] 43 Taxmann 100 (Mumbai Special Bench). Entities with abnormally high profit margins cannot be rejected outright as comparables. In the given facts of the case, two comparables sought to be included indicated unusual features for the year, which qualified for their exclusion. The inclusion of entities with supernormal profits would depend upon the facts and circumstances of each case. It should trigger further investigation to establish whether it can be taken as a comparable or not - this would depend upon whether the high profits reflect a normal business condition or whether they are a res....
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....elhi HC) Upheld the exclusion of Infosys Technologies Ltd. as a comparable. Tribunal had excluded Infosys as it was a giant company in the area of software development and it assumed all risks leading to higher profits whereas the assessee was a captive unit of the parent company and assumed only a small risk. HC upheld the reasons given by the Tribunal for the exclusion. 20. Cummins Turbo Technologies v. DDIT, [2013] 35 Taxmann 350 Companies with supernormal profits and companies which are loss-making cannot straight away be rejected as comparables unless abnormal loss is projected. 21. Google India (P) Ltd. v. DCIT, [2013] 29 Taxmann 412. Exclusion of two companies making supernormal profits. The Tribunal has consistently held that super profit making companies have to excluded from the list of comparables before making transfer pricing adjustment. 25. Maersk Global Centres (India) (P) Ltd (supra) was a Special Bench (3 Member) decision of ITAT which had to address the precise question which arises for consideration in this case, i.e whether in the facts of that case "companies earning abnormally high profit margin should be included in ....
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....having a relatively equal degree of comparability." In Exxon Mobil Company India P. Ltd. (supra), a Mumbai Bench decision, (cited at Sl. No.13 in the table above), the ITAT held: "(xi) Now, coming to the alternative arguments of the assessee that abnormal profit making unit is also to be eliminated on the same analogy on which loss making units are excluded, we, in principle, do not dispute this proposition. The various case laws relied upon by the assessee lay down that a comparable cannot be eliminated just because it is a loss making unit. Similarly, a higher profit making unit cannot also be automatically eliminated just because the comparable company earned higher profits than the average. The reason for rejecting the two loss making units is not just because they were loss making units but for the reasons which are already stated in the preceding paragraphs. If similar reasons existed in the higher profit making unit, then, it is for the assessee to bring out those reasons and seek exclusion of the same. A general argument that you have to exclude units which have high profit range, in case you exclude units which have made loss is a general submission which canno....
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....llocation of expenses were not reliable. We also hold that when direct comparables are available then segmental results of companies engaged in other business should not be taken as comparable. On the basis of these facts, we hold that Saket Projects Ltd. was not comparable to the extent wherein the various variations could be ruled out or iron out by provisions of law and rules." 26. The assessee's position is supported by reasoning in cases like the ITAT's decision in Mentor Graphics (Noida) (P.) Ltd. v. Dy. CIT [2007] 109 ITD 161 where contentions such as these were accepted: ".....The wide difference in the ratio of operating margins in the final selection of comparable ... is a clear pointer to the fact that the selection made was faulty...The OECD guideline on this point is as under '1.47 Where the application of one or more methods produces a range of figures, a substantial deviation among points in that range may indicate that the data used in establishing the some of the points may not be as reliable as the data used to establish the other points in the range or that the deviation may result from features of the comparable data that require adjustments....
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.... TPO were to be rejected. The only option then left to the Tribunal was to derive the arithmetical mean of the PLIs of the comparables which were accepted by it. In this case such comparables happen to be those of the respondent/assessee. The Tribunal, in selecting only one PLI out of a set of PLIs had clearly erred in law. However, in the facts of the present case that would not make any difference to the respondent/assessee's case in as much as even if the arithmetical mean of the comparables as accepted by the Tribunal is taken into account, the PLI would, whether the seven companies are taken into consideration or all eight companies are taken into consideration, be less than 6.99 per cent which is the PLI of the respondent/assessee for the relevant year, that is, financial year ending 31st March, 2002. We may also make it clear that the reference to the OECD Guidelines by the Tribunal in the impugned order are in the context of the reliance placed by the TPO on the very same guidelines, in particular, to para 3.27 thereof. In the present case, there are specific provisions of sub-rr. (2) and (3) of r. 10B of the said rules as also of the first proviso to s. 92C(2) of the s....
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....t be taken into consideration. The Tribunal for valid and good reasons has pointed out that Infosys Technologies Ltd. cannot be taken as a comparable in the present case. This leaves L&T Infotech Ltd. which gives us the figure of 11.11 %, which is less than the figure of 17% margin as declared by the respondent-assessee. This is the finding recorded by the Tribunal. The Tribunal in the impugned order has also observed that the assessee had furnished details of workables in respect of 23 companies and the mean of the comparables worked out to 10%, as against the margin of 17% shown by the assessee. Details of these companies are mentioned in para 5 of the impugned order. 9. In view of the aforesaid position, we do not think that any substantial question of law arises for consideration. The appeal is dismissed." 28. Quite evidently, the Court accepted the assessee's contentions with respect to dissimilarity of comparables; given the facts, equally, there was sufficient material to favour that view, in the facts of the case. The Court, unlike in Mentor Graphics (supra) did not undertake an analysis of the provisions involved- it was not also necessary, given the admitted s....
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....es incurred by third parties reflect a level of risks that is not comparable to the one assumed by the taxpayer in controlled transactions. Loss-making comparables that satisfy the comparability analysis should not however be rejected on the sole basis that they suffer losses. 3.66: A similar investigation should be undertaken for potential comparables returning abnormally large profits relative to other potential comparables." On the use of multiple year data, this is what the said guidelines provide: "B.5 Multiple Year Data 3.75: In practice, examining multiple year data is often useful in a comparability analysis, but it is not a systematic requirement. Multiple year data should be used where they add value to the transfer pricing analysis. It would not be appropriate to set prescriptive guidance as to the number of years to be covered by multiple year analyses. 3.76: In order to obtain a complete understanding of the facts and circumstances surrounding the uncontrolled transaction, it generally might be useful to examine data from both the year under examination and prior years. The analysis of such information might disclose facts that ma....
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.... of comparables while undertaking the FAR analysis of a smaller company is attractive, given that such big companies provide services to diverse clientele, perform multifarious functions, often assume risks and employ intangible assets which are specially designed, unlike in the case of smaller companies. The bigger companies have an established reputation in the segment, are well known and employ economies of scale to a telling end. On the other hand, these obvious - and apparent features should not blind the TPO from the obligation to carry out the transfer pricing exercise within the strict mandate of Section 92 C and Rules 10-A to 10-E. 31. Arm's length price determination, in respect of an international transaction has necessarily to confirm to the mandate of Rule 10B. In this case, the method followed for determining the arm's length price of the international transaction adopted by the assessee and the revenue is the TNMM. The comparability of an international transaction with an uncontrolled transaction has, in such cases, to be seen with reference to the functions performed, taking into account the assets employed or to be employed and the risks assumed by the r....
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....asonably accurate adjustments can be made to eliminate the material effects of such differences." 33. Such being the case, it is clear that exclusion of some companies whose functions are broadly similar and whose profile - in respect of the activity in question can be viewed independently from other activities- cannot be subject to a per se standard of loss making company or an "abnormal" profit making concern or huge or "mega" turnover company. As explained earlier, Rule 10B (2) guides the six methods outlined in clauses (a) to (f) of Rule 10B(1), while judging comparability. Rule 10B (3) on the other hand, indicates the approach to be adopted where differences and dissimilarities are apparent. Therefore, the mere circumstance of a company - otherwise conforming to the stipulations in Rule 10B (2) in all details, presenting a peculiar feature - such as a huge profit or a huge turnover, ipso facto does not lead to its exclusion. The TPO, first, has to be satisfied that such differences do not "materially affect the price...or cost"; secondly, an attempt to make reasonable adjustment to eliminate the material effect of such differences has to be made. 34. The Court is also aw....
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....'s data under Rule 10B(4) and that data from earlier period may also be considered if "it reveals certain facts which have an influence on the determination of transfer prices in relation to the transaction being considered". The assessee has placed significant reliance on the OECD guidelines to contend the admissibility of previous year's data for transfer pricing determination. However, for reasons given in the paragraphs below, this Court is of the opinion that the OECD guidelines have no bearing on this issue. 36. This Court holds that in the facts of the present case, the assessee was incorrect, both in its reliance placed upon previous years' data as well as the manner of such reliance. First, the assessee's justification for relying on such data is the volatility in the comparables' profit margins and the consequent inability to transact at a consistent ALP. However, this is not warranted herein. Whilst there may be a wide fluctuation in the profit margins of comparables from year-to-year, this by itself does not justify the need to take into account previous years' profit margins. The transfer pricing mechanism provided in the Act and the Rules prescribes that while dete....
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....come Tax Act. Secondly - and more importantly- the provisions of the Constitution compel a national legislation, to embody the terms of a treaty, for it to be enforceable in courts in India. This is because of Article 253 of the Constitution and the dualist tradition (of International law) followed by India, whereby treaties by themselves are legally unenforceable in courts, but are to be assimilated through municipal (or national) legislation. Our Supreme Court has, in the area of human rights -particularly in personal liberty, been emphasizing that to the extent the provision of any treaty is in consonance with provision of the Constitution (such as Article 21) it would be read along with such provision or right (Jolly George Varghese and Anr. v. The Bank of Cochin, AIR 1980 SC 470, Apparel Export Promotion Council v. A.K. Chopra, AIR 1999 SC 625; Kubic Dariusz v Union of India AIR 1990 SC 605). Thus, the Courts are primarily bound by the law on the subject in India; if the law is clear and unambiguous, there is no question of resorting to extrinsic sources. The only rider is that if the terms of such conventions or treaties are similar to the law applicable in India, courts may ....
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....ious of relying upon international conventions to which India is not a signatory and with respect to which there is no legislative mandate whatsoever. In any event, the OECD Guidelines relevant herein are in consonance with the Rules. Para 3.63 of the Guidelines states that an extreme comparable cannot be excluded "on the sole basis that the results arising from the proposed ‗comparable' merely appear to be very different from the results observed in other proposed ‗comparables'" and that "further examination would be needed to understand the reasons for such extreme results". Similarly, para 3.65 states that "loss-making comparables that satisfy the comparability analysis should not however be rejected on the sole basis that they suffer losses". Further, para 3.64 states that "it is the facts and circumstances surrounding the company in question that should determine its status as a comparable, not its financial result". The same approach is prescribed in para 3.66 for entities making supernormal profits. Therefore, both the OECD Guidelines as well as Rule 10B (2) and 10B (3) do not, in any manner, prescribe automatic exclusion of entities with extreme financial res....
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....tions with respect to the exclusion of Brescon and Khandwala Securities were based only on their exceptionally high profit margins for the assessment year in question and not on the grounds of functional dissimilarities. Indeed, the assessee did not contend the latter before the lower authorities. The assessee has sought to highlight differences in the risk profiles of the assessee and Brescon in the present appeal. However, this Court holds that such a contention cannot be raised for the first time at this stage. Therefore, Brescon and Khandwala Securities are held to be functionally similar, and the matter is remitted to the DRP for the purposes of examination under Rule 10B(3) of the Rules. In the event that the material differences arising out of the extremely high profits cannot be eliminated as per Rule 10B(3), these two entities will have to be discarded as comparables. 42. As far as Keynote is concerned, this Court notices that the assessee had challenged its inclusion as a comparable on two grounds: a) differences in the activities of Keynote and the assessee; and b) exceptionally high profit margins. The TPO rejected the first ground relying on the fact that the assess....
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....What has therefore to be determined is whether, notwithstanding the apportionment made by the respondent in the profit and loss statements, the deduction is admissible under the law." Further, a Division Bench of this Court in CIT v. Bharat General Reinsurance, 81 ITR 303 has also held that there is no estoppel against law under the Act. The Court therein held as follows: "It is true that the assessee itself had included that dividend income in its return for the year in question but there is no estoppel in the Income tax Act and the assessee having itself challenged the validity of taxing the dividend during the year of assessment in question, it must be taken that it had resiled from the position which it had wrongly taken while filing the return. Quite apart from it, it is incumbent on the income-tax department to find out whether a particular income was assessable in the particular year or not. Merely because the assessee wrongly included the income in its return for a particular year, it cannot confer jurisdiction on the department to tax that income in that year even though legally such income did not pertain to that year." For the sake of completion, this Cour....