2018 (5) TMI 144 - AT - Income Tax

Transfer Pricing Adjustment - selection of comparable - functionally dissimilarity - Held that - Assessee company was engaged in business of software development and Information Technology enables services (ITes), thus companies functionally dissimilar with that of assessee need to be deselected from final list.

Summary

Issues Involved:

1. Addition to income due to alleged difference in Arm’s Length Price (ALP) of international transactions.
2. Rejection of quantitative and qualitative filters applied by the assessee for selecting comparables.
3. Incorrect analysis of functions performed, assets employed, and risks assumed (FAR analysis).
4. Rejection of entitlement for downward adjustment in margins based on risk adjustments.
5. Exclusion of foreign exchange gain from operating profit while calculating margins.
6. Selection of consolidated financial results instead of standalone financials for computing margins.

Detailed Analysis:

1. Addition to Income Due to Alleged Difference in ALP:
The assessee challenged the addition of ?2,27,84,888/- made by the Commissioner of Income Tax (Appeals) [CIT(A)] due to the alleged difference in the Arm’s Length Price (ALP) of international transactions. The Tribunal noted that the assessee used the Transactional Net Margin Method (TNMM) with Operating Profit/Total Cost (OP/TC) as the Profit Level Indicator (PLI). The Transfer Pricing Officer (TPO) excluded foreign exchange gain from the operating income, resulting in an adjusted PLI of 13.61% for the assessee, compared to the average margin of 29.52% for selected comparables. This adjustment was upheld by the CIT(A).

2. Rejection of Quantitative and Qualitative Filters:
The assessee argued that the TPO arbitrarily rejected the filters applied by the assessee and selected functionally different comparables. The Tribunal examined the comparables selected by the TPO and directed the exclusion of certain companies (Aricent Technologies, Bodhtree Consulting, CAT Technologies, KPIT Cummins Infosystems, TechMahindra, and Thirdware Solutions) due to reasons such as high Related Party Transactions (RPT), diversified business activities, and lack of segmental results.

3. Incorrect Analysis of FAR:
The Tribunal addressed the assessee’s claim that the CIT(A) and TPO did not correctly analyze the characteristics of functions performed, assets employed, and risks assumed (FAR analysis). The Tribunal found that some of the comparables selected by the TPO were not functionally similar to the assessee and directed their exclusion.

4. Rejection of Entitlement for Downward Adjustment in Margins:
The Tribunal did not specifically address the issue of downward adjustment in margins based on risk adjustments. However, it directed the TPO to re-compute the average margin of the comparables after excluding certain companies, which could impact the overall adjustment.

5. Exclusion of Foreign Exchange Gain from Operating Profit:
The TPO excluded foreign exchange gain from the operating profit, arguing that it depended on the risk management policy of each company. The Tribunal did not specifically address this issue in the final judgment, as it was not argued in detail by the assessee.

6. Selection of Consolidated Financial Results:
The Tribunal did not specifically address the issue of using consolidated financial results instead of standalone financials for computing margins. The focus was primarily on the selection and exclusion of comparables.

Conclusion:
The Tribunal partly allowed the appeal for statistical purposes, directing the TPO to re-compute the average margin of the comparables after excluding certain companies and make necessary adjustments to the international transaction. The decision emphasized the need for accurate comparability analysis and adherence to appropriate filters for determining the ALP. The Tribunal’s directions aimed to ensure a fair and consistent basis for comparison, addressing the concerns raised by the assessee regarding the selection of comparables and computation of margins.