2016 (3) TMI 1138 - AT - Income Tax

Transfer pricing adjustment - selection of comparable - DRP excluding the comparable companies having related party transaction - Held that - It has been pointed out by the ld. DR that the CIT(Appeals) has directed the TPO to exclude the companies which have Related Party Transactions (RPT) without specifying the exact percentage of RPT to be taken as threshold limit. We find that the TPO has not applied any filter of RPT for selection of comparable companies. The CIT(Appeals) while passing the impugned order held that there is no need for inclusion of the companies which have RPT and accordingly directed the AO to exclude the companies having RPT from the comparables. It is pertinent to note that in the normal circumstances the Tribunal has considered 15% as threshold limit of RPT when there is no difficulty of finding the comparable companies. Therefore in view of the fact that the CIT(Appeals) has not fixed any threshold limit of RPT we modify the impugned order of the CIT(A) and direct the AO/TPO to apply 15% RPT as threshold limit for the purpose of selecting comparables. This ground of the Revenue s appeal is partly allowed. Exclusion of comparable companies having abnormal/high profit margin - Held that - Merely a company or entity having a high profit margin or high loss cannot be a reason for exclusion or inclusion in the list of comparables. However if the high profit or high loss is as a result of some abnormal event or circumstances in a particular comparable company the same is to be investigated and examined and if it is found that due to the said particular extra-ordinary or abnormal circumstances the said company cannot be regarded as functionally comparable to that of assessee then only it is to be excluded from the list of comparables. Accordingly we direct the AO/TPO to further verify and investigate the actual reason of the high profit margin of the company and then decide the issue in the light of the finding of the Special Bench in the case of Maersk Global Centres (India) (P.) Ltd. (2014 (3) TMI 891 - ITAT MUMBAI ). Exclusion of certain comparable companies by the CIT(A) by applying the turnover filter - Held that - Classification of comparables on the basis of companies selected on turnover basis is not appropriate and acceptable. The turnover no doubt is a relevant factor to be taken into account but there should be some proper and reasonable parameter to apply the difference of turnover between the assessee and the comparable which may be a multiple in the range of 2 times 3 times X times or any other number of times which should be applied to all the comparable companies instead of taking a slab from Rs. 1 crore to Rs. 200 crores. Thus if appropriate multiple to say 10 times is applied then the assessee having turnover of Rs. 8.15 crores can be compared with a company which is having a turnover of Rs. 81.5 crores. Accordingly in view of the above facts of the case we set aside this issue to the record of the AO/TPO to apply appropriate multiple or differential factor regarding the turnover of the comparable and the assessee. Exclusion of telecommunication expenses and other expenses in foreign currency from total turnover as well - Held that - If the export turnover in the numerator is to be arrived at after excluding certain expenses the same should also be excluded in computing the export turnover as a component of total turnover in the denominator. The reason being the total turnover includes export turnover. The components of the export turnover in the numerator and the denominator cannot be different. Formula will be Profits of the business of the undertaking Export turn over / (Export turnover domestic turn over) Total Turn Over See ACIT v. Tata Elxsi Ltd. 2011 (8) TMI 782 - KARNATAKA HIGH COURT

Summary

Issues Involved:
1. Exclusion of comparables with Related Party Transactions (RPT).
2. Exclusion of comparables with abnormal/high profit margins.
3. Exclusion of certain comparables based on turnover.
4. Exclusion of telecommunication and other expenses in foreign currency from total turnover.

Detailed Analysis:

1. Exclusion of Comparables with Related Party Transactions (RPT):
The Revenue contested the CIT(A)'s direction to exclude companies with Related Party Transactions (RPT) from the list of comparables. The Tribunal noted that the CIT(A) did not specify a threshold limit for RPT. It was highlighted that typically, a 15% threshold limit for RPT is considered reasonable. The Tribunal modified the CIT(A)'s order, directing the AO/TPO to apply a 15% RPT threshold for selecting comparables. This ground of the Revenue’s appeal was partly allowed.

2. Exclusion of Comparables with Abnormal/High Profit Margins:
The Revenue challenged the CIT(A)'s decision to exclude companies with abnormal/high profit margins from the list of comparables. The Tribunal referred to the Special Bench decision in Maersk Global Centres (India) (P.) Ltd., which stated that companies cannot be excluded solely based on high profit margins. Instead, further investigation is required to determine if high profits are due to normal business conditions or extraordinary circumstances. The Tribunal directed the AO/TPO to investigate the reasons for high profit margins and decide the issue accordingly.

3. Exclusion of Certain Comparables Based on Turnover:
The CIT(A) had excluded five companies from the list of comparables because their turnover exceeded Rs. 200 crores. The Tribunal found this turnover slab inappropriate, as it could lead to inconsistent results. Instead, a more reasonable parameter or multiple should be applied to compare turnovers. The Tribunal set aside this issue, directing the AO/TPO to apply an appropriate multiple or differential factor regarding the turnover of the comparables and the assessee.

4. Exclusion of Telecommunication and Other Expenses in Foreign Currency from Total Turnover:
The Revenue disputed the exclusion of telecommunication expenses and other foreign currency expenses from the total turnover. The Tribunal referred to the jurisdictional High Court's decision in ACIT v. Tata Elxsi Ltd., which held that such expenses should be excluded from both export turnover and total turnover to maintain consistency in the formula for computing deductions under Section 10A. Following this precedent, the Tribunal upheld the CIT(A)'s decision, finding no error or illegality.

Conclusion:
The Tribunal partly allowed the Revenue's appeal, modifying the CIT(A)'s order regarding the RPT threshold and directing further investigation into high profit margins and appropriate turnover comparisons. The Tribunal upheld the CIT(A)'s decision on excluding telecommunication and foreign currency expenses from the total turnover. The judgment was pronounced on March 31, 2016.