2025 (4) TMI 1253 - AT - Income Tax

TP Adjustment - rejection of internal TNMM for the purpose of benchmarking the international transaction of the assessee-company with its AE - HELD THAT - Assessee-company has not filed any evidence except a Certificate from the Accountant to prove it s claim. From the details filed by the assessee-company we are of the considered view that the assessee-company has failed to demonstrate that the AEs and Non-AEs are functionally comparable. Further the nature of the transactions with AEs and Non-AEs along with terms were not produced to substantiate the functional comparability. Non- Associated Enterprises transactions were predominantly from Indian operations whereas Associated Enterprises transactions were outside India. No explanation was given for the assessee-company s geographical differences in it s transactions and how much material difference was adjusted for the purpose of comparability. The assessee- company failed to prove segmental allocation on actual basis. Therefore we are of the considered view that when there is no evidence to prove the argument of the assessee- company in respect of Internal-TNMM it is difficult for us to accept the contention of the assessee-company that Internal-TNMM is an appropriate parameter for benchmarking the international transaction with it s AEs. Thus we reject the argument of the assessee-company and reject ground nos.2 and 3 of the assessee s appeal. Rejection of TP study conducted by the assessee-company and fresh TP study conducted by the TPO - In the present case going by the reasons given by the TPO and by the DRP we find that TP study conducted by the assessee-company is not in accordance with provisions of sec. 92CA(3) of the Act because the assessee-company has failed to prove with relevant evidences that it applied appropriate filters while selecting comparable companies and also maintain relevant data to prove the comparability analysis of comparable companies. We further note that Rule-10B in this regard requires to use of current year data even if it is subsequently available at the time of determination of ALP during the course of assessment proceedings. From the words of Rule-10B(5) it is very clear that the current year data has to be necessarily considered for the purpose of comparable analysis. Since the assessee-company had not considered current year data for its comparability analysis in our considered view the filters adopted by the assessee- company for selection of comparable companies is not in accordance with sec. 92CA(3) of the Income Tax Act 1961 and Rule 10B(5) of the Income Tax Rules 1962. Therefore there is no merit in the grounds taken by the assessee-company challenging the reasons given by the TPO/DRP for rejection of TP analysis conducted by the assessee-company. Exclusion of 13 comparables on the ground of functional dissimilarity superior profit and turnover and other appropriate filter etc. - Although the assessee-company contended for application of Rs. 0 to Rs. 200 crore turnover is appropriate turnover filter for exclusion of certain companies but in our considered view going by the settled principle of law by the decisions of various Tribunals application of 10 times upper and lower limit of turnover at a company is appropriate for exclusion of companies for the purpose of comparability of analysis. If we apply 10 times lower or upper turnover limits for companies then in our considered view going by the revenue earned by the assessee-company of Rs. 34 crores approximately in our considered view the above 05 companies viz. Cybage Software Pvt. Ltd. Tata Elxsi Ltd. Persistent Systems Ltd. Larsen Toubro Infotech Ltd. and Infosys Ltd. are having turnover of above the tolerance range fixed for inclusion of companies. Therefore we are of the considered view that Cybage Software Pvt. Ltd. Tata Elxsi Ltd. Persistent Systems Ltd. Larsen Toubro Infotech Ltd. and Infosys Ltd. are definitely not comparable to assessee-company on turnover filter itself. Thus we direct the TPO to exclude the above 05 companies for the purpose of benchmarking the ALP of international transaction of the assessee-company with its AE. Coming back to Thirdware Solution Ltd. Aspire Systems (India) Pvt. Ltd. and Nihlent Ltd. although the assessee-company seeks to exclude these 03 companies on Rs. 0 to Rs. 200 crore turnover filter but in our considered view since we have applied 10 times upper and lower limit for exclusion of companies and if we apply the said limit the above 03 companies are coming within the range of turnover fixed for comparable analysis and thus on this ground these 03 companies cannot be excluded from the list of comparables. Therefore we reject the argument of the Counsel for the assessee-company. When it comes to software development services it has a bundle of services which includes project engineering enterprise solution independent testing services and application of support services and these are services comes under one segment of software development services although may be in a different business segments. Therefore going by the description provided in the annual report of the relevant companies it cannot be said that these 03 companies are engaged in a different or diversified activities and there is no segmental data available in respect of each segments. Since the functions performed by the assessee-company are similar that of the functions carried-out by the above 03 companies in our considered view the above 03 companies are functionally similar to the assessee-company and comparable to the assessee-company. We are therefore of the considered view that the DRP has rightly included the above 03 in the list of final set of comparables. We therefore uphold the findings of DRP and reject the ground taken by the assessee-company. Exclusion of R S Software (India) Ltd - Once the company is engaged in providing software development services which may be in respect of other segments of business but when said services comes under one umbrella of software development services then the question of segmental information for comparison purpose does not arise. Since the assessee itself has selected the company in it s TP study and further the assessee failed to make-out a case that it is functionally dissimilar from the assessee-company in our considered view based on certain decisions the said company cannot be excluded. Thus we reject the arguments of the Counsel for the Assessee and uphold the reasons given by the DRP for inclusion of R S Software (India) Ltd. in the final set of comparables. Inclusion of 08 companies which were earlier considered in the TP study of the assessee - Once the company is engaged in providing software development services even if it is providing said services to multiple segments of business in our considered view once the services rendered by the companies is comes under one umbrella of software development services then merely for the reason of said companies providing services to diversified segment businesses those companies cannot be excluded for the purpose of comparison of analysis. In the present case going by the reasons given by the TPO in our considered view the TPO has given stereotype reasons for all companies even though the evidences filed by the assessee clearly demonstrates that the said companies are providing software development services and derived 100% revenue from one segment. Further the assessee had also proved with evidences that all these companies have passed the filters applied by the TPO. Therefore TPO was erred in excluding the said companies from the list of comparables. The DRP without appreciating the relevant facts simply upheld the reasons given by the TPO and excluded the above 08 companies from the list of comparables. Thus we set aside the order of DRP/TPO and direct the AO/TPO to include the above 08 companies in the list of final set of comparables for the purpose of comparison of international transactions of the assessee-company with it s AEs. Exclusion of Kals Information Systems Private Limited and Cigniti Technologies Limited from the final list of comparable companies - Although the DRP has directed the TPO to exclude the above 02 companies but the Learned Counsel for the Assessee submitted that the TPO has not given full effect to the directions of the DRP to exclude the above 02 companies. In our considered view once the DRP has given a direction to the TPO/AO to exclude or include any company the Assessing Officer/TPO is bound to give full effect to the directions of the DRP without any modifications. Therefore we direct the Assessing Officer/TPO to verify the fact and give effect to the order of the DRP in toto and exclude the above 02 companies viz. Kals Information Systems Private Limited and Cigniti Technologies Limited from the final list of comparable companies.

Summary

The core legal issues considered by the Tribunal in this appeal primarily relate to the determination of the arm's length price (ALP) in international transactions under the Transfer Pricing (TP) provisions of the Income Tax Act, 1961, specifically for the assessment year 2016-2017. The issues include:

1. Whether the rejection of the internal Transactional Net Margin Method (TNMM) by the Assessing Officer (AO) and Dispute Resolution Panel (DRP) was justified.

2. Whether the TP study conducted by the assessee was rightly rejected and the fresh TP study by the Transfer Pricing Officer (TPO) was appropriate.

3. Whether certain companies selected or excluded as comparables for benchmarking were rightly included or excluded based on functional comparability, turnover, profit margins, and other filters.

4. Whether the AO/TPO gave full effect to the directions of the DRP regarding exclusion of specific comparable companies.

5. Legality of disallowance of employees' contribution to ESI and interest paid on TDS default.

6. Validity of levy of interest under sections 234A, 234B, and 234C consequent to the assessment.

Issue-wise Detailed Analysis

1. Rejection of Internal TNMM for Benchmarking International Transactions (Grounds 2 and 3)

Legal Framework and Precedents: The Transfer Pricing provisions under sections 92C and 92CA of the Income Tax Act require that international transactions between associated enterprises be benchmarked at arm's length price using prescribed methods, including TNMM. Internal TNMM, where margins from transactions with associated enterprises are compared with those from independent parties, is permissible if functional comparability and other conditions are met.

Court's Interpretation and Reasoning: The assessee claimed that its internal TNMM demonstrated cost plus 10% margin on transactions with associated enterprises (AEs), while transactions with non-AEs showed a negative margin. The assessee submitted an auditor's certificate and a chart segregating AE and non-AE transactions. However, the Tribunal noted that the assessee failed to provide sufficient documentary evidence to substantiate that the transactions with AEs and non-AEs were functionally comparable. There was no evidence of separate books or detailed terms of transactions to establish comparability. Additionally, geographical differences (transactions with AEs were outside India, with non-AEs predominantly within India) were not accounted for. The Tribunal emphasized that without evidence of functional comparability and adjustment for material differences, internal TNMM could not be accepted.

Application of Law to Facts: The Tribunal found that the assessee did not meet the evidentiary requirements under section 92CA and Rule 10B to substantiate internal TNMM as the appropriate method. The absence of current year data and lack of detailed functional analysis led to rejection of internal TNMM.

Treatment of Competing Arguments: The AO and DRP rejected internal TNMM due to lack of evidence, while the assessee argued on the basis of submitted documents and auditor's certificate. The Tribunal sided with the AO/DRP, emphasizing evidentiary requirements.

Conclusion: The rejection of internal TNMM was upheld and grounds 2 and 3 were dismissed.

2. Rejection of Assessee's TP Study and Acceptance of TPO's Fresh TP Study (Grounds 4, 5, and 6)

Legal Framework and Precedents: Under section 92CA(3), the TPO may reject the TP study of the assessee if the information or data used is unreliable or incorrect and conduct a fresh TP analysis. Rule 10B mandates use of current year data for comparable analysis.

Court's Interpretation and Reasoning: The assessee's TP study was rejected by the TPO and DRP on the ground that the filters applied to select comparables were inappropriate and did not use current year data. The Tribunal noted that the assessee failed to provide evidence showing that the filters were appropriate or that current year data was considered. The TPO's fresh study selected comparables with a significantly higher operating margin (26.36%) compared to the assessee's claimed margin (4.81%), resulting in a substantial TP adjustment.

Application of Law to Facts: The Tribunal held that the TPO was justified in rejecting the assessee's TP study due to non-compliance with statutory requirements and lack of reliable data. The fresh TP study was conducted in accordance with law and Rule 10B.

Treatment of Competing Arguments: The assessee contended that its filters were appropriate and that the TPO's rejection was unjustified. The AO and DRP emphasized statutory compliance and reliability of data. The Tribunal agreed with the AO/DRP.

Conclusion: Grounds 4, 5, and 6 were rejected, upholding the TPO's fresh TP study and resultant adjustment.

3. Exclusion of 13 Comparable Companies on Grounds of Functional Dissimilarity, Super Profit, Turnover, and Other Filters (Grounds 7 and 10)

Legal Framework and Precedents: Selection of comparables must satisfy functional analysis, turnover thresholds, and other filters to ensure comparability under section 92CA and Rule 10B. Turnover filters often apply a tolerance range, commonly 10 times the assessee's turnover, for inclusion or exclusion.

Court's Interpretation and Reasoning: The assessee sought exclusion of eight companies with turnovers exceeding Rs. 200 crores, arguing functional dissimilarity and super profits. The Tribunal examined turnover data and functional analysis. It held that five companies with turnovers exceeding 10 times the assessee's turnover (Rs. 34 crores) were rightly excluded. However, three companies with turnovers within the 10 times range were rightly retained. The Tribunal found no material functional dissimilarity with these three companies, noting that software development services encompass a bundle of related activities under one segment. The assessee's arguments on R&D expenditure and segmental details were insufficient to exclude these companies.

Regarding exclusion of R S Software (India) Ltd., the Tribunal held that mere reference to a Tribunal order or lack of segmental data was insufficient. The company was functionally comparable, engaged predominantly in software development services, and thus inclusion was justified.

Application of Law to Facts: The Tribunal applied the 10 times turnover tolerance and functional analysis principles, rejecting exclusion of companies outside this threshold and upholding inclusion of functionally comparable companies.

Treatment of Competing Arguments: The assessee emphasized turnover and functional dissimilarity; the AO and DRP relied on FAR analysis and accepted comparability within the turnover tolerance. The Tribunal balanced these views, partially accepting and partially rejecting the assessee's contentions.

Conclusion: Five companies were excluded; three companies and R S Software (India) Ltd. were retained as comparables.

4. Inclusion of Eight Companies Previously Considered by the Assessee but Excluded by TPO/DRP (Ground 9)

Legal Framework and Precedents: Comparable companies must pass all filters including functional analysis, turnover, and data availability. Exclusion must be supported by cogent reasons and evidence.

Court's Interpretation and Reasoning: The assessee argued that the TPO/DRP excluded eight companies without proper appreciation of their functional similarity and filter compliance. The Tribunal found that the TPO gave stereotyped reasons citing dissimilar FAR and lack of evidence. The assessee submitted annual report extracts showing these companies derived 100% revenue from software development services, indicating functional similarity.

Application of Law to Facts: The Tribunal held that exclusion without detailed evidence or proper reasoning was not in accordance with section 92CA(3). It emphasized that companies providing software development services under one segment should not be excluded merely due to diversified business segments.

Treatment of Competing Arguments: The assessee provided documentary evidence supporting inclusion; the TPO/DRP relied on general observations. The Tribunal found the assessee's evidence more persuasive.

Conclusion: The Tribunal set aside the orders of TPO/DRP on this issue and directed inclusion of these eight companies in the final comparables list.

5. Non-Giving of Full Effect to DRP Directions Regarding Exclusion of Two Companies (Ground 12)

Legal Framework and Precedents: Directions of the DRP under section 144C(5) are binding on the Assessing Officer and TPO and must be given full effect without modification.

Court's Interpretation and Reasoning: The DRP directed exclusion of Kals Information Systems Private Limited and Cigniti Technologies Limited. The assessee contended that the TPO/AO did not fully comply. The Tribunal emphasized the binding nature of DRP directions and directed the AO/TPO to exclude these companies in full compliance with DRP's order.

Conclusion: Direction was given to the AO/TPO to give full effect to DRP's exclusion of the two companies.

6. Disallowance of Employees' Contribution to ESI and Interest Paid on TDS Default (Grounds 14 and 15)

The assessee did not press these grounds at hearing. Accordingly, these grounds were dismissed as not pressed.

7. Levy of Interest under Sections 234A, 234B, and 234C (Ground 16)

The Tribunal held that levy of interest under these sections is consequential to the total income determined by the AO. The AO was directed to verify the assessee's claim in light of the final income and levy interest in accordance with law.

Significant Holdings

"The assessee-company has failed to demonstrate that the AEs and Non-AEs are functionally comparable. Further, the nature of the transactions with AEs and Non-AEs along with terms were not produced to substantiate the functional comparability."

"When there is no evidence to prove the argument of the assessee-company in respect of Internal-TNMM, it is difficult for us to accept the contention of the assessee-company that Internal-TNMM is an appropriate parameter for benchmarking the international transaction with its AEs."

"The TPO was justified in rejecting the TP study conducted by the assessee-company as the assessee-company has failed to prove with relevant evidences that it applied appropriate filters while selecting comparable companies and also maintain relevant data to prove the comparability analysis."

"Application of 10 times upper and lower limit of turnover at a company is appropriate for exclusion of companies for the purpose of comparability of analysis."

"Once the company is engaged in providing software development services, even if it is providing said services to multiple segments of business, those companies cannot be excluded for the purpose of comparison of analysis."

"Directions of the DRP are binding on the Assessing Officer/TPO and must be given full effect without any modifications."

Final Determinations

The Tribunal dismissed the general grounds and those relating to internal TNMM, upheld the TPO's fresh TP study and resultant adjustments, excluded five high turnover companies from the comparables list, retained three companies and R S Software (India) Ltd. as comparables, directed inclusion of eight companies previously excluded by the TPO/DRP, and ordered the AO/TPO to give full effect to DRP's directions excluding two companies. Grounds relating to disallowance of ESI contribution and interest on TDS default were dismissed as not pressed, and the levy of interest under sections 234A, 234B, and 234C was left to be decided in accordance with law based on final income determination. The appeal was partly allowed for statistical purposes.