2016 (1) TMI 116 - AT - Income Tax

Transfer pricing adjustment - selection of comparable - Held that - From a perusal of the order of the DRP, it is clear that the assessee s objections / contentions against the inclusion/exclusion of the comparables has not been dealt by the DRP while exercising the appellate jurisdiction against a quasi-judicial order of the TPO, which exercise is sine qua non for deciding the issue as to whether a comparable is comparable to the FAR of the tested party i.e. assessee. Simply by observing that tested party is broadly comparable will not suffice. We are of the opinion that the DRP cannot absolve from its duty without going into the merits of the contention of the assessee as to whether a comparable company is comparable to it or not as envisaged by the Act and Rules governing the subject. Since the DRP has not met the contention of the assessee in respect of inclusion/exclusion of comparable in its order, we deem it fit to remand the matter back to the file of DRP for fresh adjudication. Ex consequenti, the DRP order is set aside and the matter remanded back to the file of the DRP for passing a speaking order in respect of all the grounds raised before it and has to deal with each of the comparables contested above by the assessee. Needless to say that when considering the arguments in respect to selection of the comparables, the DRP must keep in mind the following aspects - (a) Companies with extra ordinary circumstances, like those which suffered events like merger/demerger, impacting the financial results could not be treated as comparables; (b) Companies which are functionally dissimilar cannot be taken as comparables; (c) Companies acting merely as intermediary having outsourced its activity cannot be considered as comparables; (d) Companies whose directors were involved in fraud cannot be taken as comparable, as their financials are not reliable. The aforesaid aspects may be kept in mind by the DRP while addressing the objections in respect to inclusion / exclusion of comparables and pass a speaking order after giving adequate opportunity to the assessee. - Decided in favour of assessee for statistical purposes

Issues Involved:
1. Inclusion/Exclusion of Comparables
2. Application of Filters by TPO
3. Adjustments for Extraordinary Circumstances
4. Functional Dissimilarity of Comparables
5. Outsourcing Business Model
6. Financial Year Ending Filter
7. Risk Adjustment

Detailed Analysis:

1. Inclusion/Exclusion of Comparables:
The primary grievance of the assessee was regarding the inclusion and exclusion of certain comparables by the Transfer Pricing Officer (TPO). The assessee argued that the TPO included companies that were not comparable in terms of functions performed, assets employed, and risks assumed. The Dispute Resolution Panel (DRP) did not address these objections adequately, leading to the matter being remanded back for fresh adjudication.

2. Application of Filters by TPO:
The TPO applied arbitrary quantitative and qualitative filters, leading to the selection of 20 comparables for Contract Software Development (CSD) services and 21 for Information Technology enabled Services (ITES). The assessee contested the inconsistency in applying filters, particularly the wages/sales ratio filter, which was applied selectively.

3. Adjustments for Extraordinary Circumstances:
The assessee contended that companies undergoing mergers, demergers, or other extraordinary circumstances should not be considered as comparables. Specific companies like Accentia Technologies Limited, Asit C. Mehta Financial Services Limited, Mold-Tek Technologies Limited, and Wipro Ltd. were highlighted for undergoing such changes, which impacted their financial results.

4. Functional Dissimilarity of Comparables:
Several companies included by the TPO were argued to be functionally dissimilar. For instance, Crossdomain Solution P Ltd. was involved in software development services, and Eclerx Services Limited was engaged in high-end Knowledge Process Outsourcing (KPO) services, unlike the assessee's ITES segment.

5. Outsourcing Business Model:
The assessee argued that companies like Coral Hub Limited, which outsourced most of its services to third-party contractors, could not be considered comparable due to their different business models. The low employee cost to sales ratio was cited as evidence of this outsourcing model.

6. Financial Year Ending Filter:
The assessee pointed out that HCL Comnet Systems & Services Ltd. had a financial year ending on June 30, 2008, which did not align with the financial year filter applied by the TPO. This discrepancy was argued to disqualify HCL Comnet as a comparable.

7. Risk Adjustment:
The assessee argued that since it was remunerated on an arm's length cost-plus basis, it undertook minimal business risks compared to full-fledged risk-taking entrepreneurs. Therefore, a risk adjustment should be allowed. However, the DRP rejected this argument, stating that mechanical adjustments could not be made without robust data.

Conclusion:
The Income Tax Appellate Tribunal (ITAT) observed that the DRP did not adequately address the assessee's objections regarding the inclusion/exclusion of comparables. The ITAT remanded the matter back to the DRP for fresh adjudication, instructing it to pass a speaking order addressing each of the grounds raised by the assessee. The DRP was directed to consider aspects such as extraordinary circumstances, functional dissimilarity, outsourcing models, and financial year filters while re-evaluating the comparables.

Order:
The appeal of the assessee was allowed for statistical purposes, and the matter was remanded back to the DRP for fresh adjudication. The DRP was instructed to provide a detailed and reasoned order after giving adequate opportunity to the assessee.

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