2019 (1) TMI 1194 - AT - Income Tax

TPA - comparable selection - Held that - It is observed that assessee included companies having financial data of at least 2 years prior for which Ld.TPO observes that as per Rule 10 B (4) it is mandatory to use current year data, unless it is shown by assessee that such earlier years data has an influence in determining transfer price and that, use of earlier year data is in addition to current year data. Ld.TPO rejected company, where current year data was not available and assessee had sought to rely upon preceding two years data, which in our considered opinion is appropriate as assessee has not been able to establish what is required under rule 10 B (4) of Income Tax Rules 1963. Next filter that has been modified by TPO is in respect of turnover. Assessee had included companies with an average sales of less than 1 crore during the year and companies with more than 50 crores were rejected. TPO observed that companies whose income is less than 5 crore would be appropriate as otherwise analysis may not lead to proper compatibility. It is observed that TPO modified lower limit of turnover filter from less than 1 crore to less than 5 crore. TPO rejected companies which are making losses as comparables. This shows that there is a limit for lower end for identifying comparables. In such a situation, we are unable to understand as to why there should not be an upper limit also. What should be an appropriate upper limit is another factor to be considered. Big company would be in a position to bargain price and also attract more customers. It would also have a broad base of skilled employees who are able to give better output. A small company may not have these benefits and therefore, turnover also would come down reducing profit margin. Thus, as held by various benches of this Tribunal, when companies which are loss making are excluded from comparables, then super profit making companies should also be excluded. Thus in present case, rage of 1 crores to 200 crores would be ideal. For purposes of classification of companies on the basis of net sales or turnover, we find that a reasonable classification has to be made. In our opinion companies with revenues less than 75% from software development services would be ideal to be excluded, as economic circumstances of such companies would be different. We draw our support from Rule 10 B (2) in respect of this view. Assessee is into rendering of software development services like that of assessee thus these companies functionally dissimilar with that of assessee need to be deselected from final list.

Issues Involved:
1. Legality of the Assessing Officer's order.
2. Arm's length adjustment to international transactions.
3. Ignoring facts in submissions by the Assessing Officer.
4. Rejection of economic analysis by the Transfer Pricing Officer (TPO).
5. Arbitrary modification of filters by the TPO.
6. Rejection of comparables by the TPO.
7. Inclusion of companies with high turnover as comparables.
8. Erroneous computation of related party transactions.
9. Ignoring Functions, Assets, and Risk Profile (FAR) analysis.
10. Ignoring differences in risk profiles.
11. Denial of working capital adjustment.

Detailed Analysis:

1. Legality of the Assessing Officer's Order:
The appellant argued that the order of the Learned Assessing Officer (AO) is "bad in law and on the facts and circumstances of the case." However, the tribunal did not find it necessary to adjudicate this general ground separately and dismissed it.

2. Arm's Length Adjustment:
The TPO made an arm's length adjustment of ?52,25,570/- to the appellant’s international transactions with associated enterprises. The appellant contested this adjustment, arguing that the TPO's determination was erroneous and based on subjective grounds and presumptions.

3. Ignoring Facts in Submissions:
The appellant claimed that the AO ignored the facts presented in the submissions and proceeded to make the transfer pricing adjustment based solely on the TPO's order. The tribunal noted that the AO should have considered the facts submitted by the appellant.

4. Rejection of Economic Analysis:
The appellant contended that the TPO rejected the economic analysis conducted by the appellant for determining the arm's length price. The tribunal observed that the TPO modified the filters used by the appellant, which rendered the economic analysis inadequate.

5. Arbitrary Modification of Filters:
The TPO applied various filters arbitrarily, such as turnover filter less than ?5 crore, export revenues less than 75% of total revenues, and companies with related party transactions (RPT) of 25% or more. The tribunal held that these modifications were inappropriate and that a reasonable classification should be made.

6. Rejection of Comparables:
The TPO rejected several comparables submitted by the appellant and included others with an average margin of 20.33%. The tribunal directed the TPO to exclude certain comparables and to carry out a proper FAR analysis.

7. Inclusion of Companies with High Turnover:
The appellant argued that companies with very high turnover should not be considered as comparables. The tribunal agreed, stating that companies with significantly higher turnover have different economic circumstances and should be excluded.

8. Erroneous Computation of Related Party Transactions:
The appellant claimed that the TPO erroneously computed related party transactions of selected companies. The tribunal directed the TPO to re-examine the computation.

9. Ignoring Functions, Assets, and Risk Profile (FAR) Analysis:
The appellant argued that the TPO ignored the FAR profile of the companies selected as comparables. The tribunal emphasized the importance of conducting a proper FAR analysis to determine comparability.

10. Ignoring Differences in Risk Profiles:
The appellant contended that the TPO ignored the differences in risk profiles between the appellant and the comparables. The tribunal directed the TPO to consider these differences and make necessary adjustments.

11. Denial of Working Capital Adjustment:
The appellant argued that the TPO denied adjustments for differences in working capital requirements. The tribunal directed the TPO to consider working capital adjustments while determining the arm's length price.

Conclusion:
The tribunal allowed the appeal for statistical purposes, directing the TPO to undertake a proper FAR analysis and to apply appropriate filters for determining the arm's length price. The tribunal emphasized the importance of considering functional compatibility, assets owned, and risks assumed in the comparability analysis. The appeal was allowed for statistical purposes, and the order was pronounced in the open court on 15/01/2019.

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