2025 (4) TMI 1026 - AT - Income Tax

TP Adjustment - comparable selection - HELD THAT - After deselection of compnaies as functionally dissimilar we are of the view that ALP as computed by the TPO in the present facts and circumstances of the case is fair and reasonable to the extent of 11 comparables except M/s Ashoka Highways (Durg) Ltd. who has operating margin of 38% from toll operation business. Accordingly we direct the AO to exclude the company M/s Ashoka Highways (Durg) Ltd. from the list of comparables and recompute the adjustment to be made in specified domestic transaction based on the average PLI for remaining 11 comparables as taken by the TPO.

Summary

The principal issues considered in this appeal pertain to the determination of the arm's length price (ALP) in respect of specified domestic transactions between the appellant joint venture (JV) and its associated enterprise (AE). The core legal questions examined include:

1. Whether the AE (KSSIIPL) can be treated as the tested party for benchmarking the transactions under the Transactional Net Margin Method (TNMM), or whether the appellant JV itself should be the tested party;

2. The permissibility and appropriateness of using multiple years' data for selecting comparables under Rule 10B(4) of the Income Tax Rules;

3. The correctness of the selection and rejection of comparables by the Transfer Pricing Officer (TPO), including the addition of new comparables by the TPO;

4. The validity of the TPO's rejection of certain comparables on grounds of functional dissimilarity or financial performance;

5. The treatment of an outlier comparable (Ashoka Highways (Durg) Ltd.) with an exceptionally high operating margin in the computation of ALP.

Issue 1: Selection of Tested Party under TNMM

The legal framework governing the selection of the tested party under the TNMM is primarily Rule 10B(1)(e) of the Income Tax Rules, 1962, which requires computation of net profit margin realized by the enterprise from the specified domestic transaction in relation to costs incurred, sales effected, or assets employed. Rule 10B(2) and (3) prescribe factors to judge comparability, including functions performed, assets employed, risks assumed, and contractual terms. The 2010 OECD Transfer Pricing Guidelines (para 3.18) provide that the tested party should be the one with the least complex functional profile, facilitating reliable application of the transfer pricing method and comparability analysis.

The appellant contended that the AE, KSSIIPL, undertakes all critical functions and risks related to the EPC contract, while the appellant JV performs limited functions, merely subcontracting the work. Therefore, the appellant argued that KSSIIPL should be the tested party, as it is functionally engaged in routine execution of engineering projects with comparable data available in the public domain, whereas the appellant JV lacks reliable third-party comparables due to its limited role.

The TPO rejected this contention, holding that KSSIIPL's accounts include significant third-party transactions, and the net profit margin of KSSIIPL's overall business cannot be reliably attributed solely to the specified domestic transaction with the appellant. The TPO emphasized that the tested party should be the entity with the least complex functions and risks, which in this case is the appellant JV. This position was supported by the Tribunal's reliance on judicial precedents, including the Madras High Court decision in Virtusa Consulting Services Pvt Ltd, which underscored that the tested party is generally the one with the least complex functional analysis and for which reliable comparables can be found. The Tribunal also referred to the Delhi Tribunal's decision in Ranbaxy Laboratories Ltd., which held that the tested party should be the party for which reliable data is readily available and requiring fewer adjustments, regardless of whether it is local or foreign.

Applying these principles to the facts, the Tribunal observed that the appellant JV's entire income arises from the specified domestic transaction, making its net profit margin directly attributable and ascertainable, unlike the AE whose revenue from the specified domestic transaction constitutes only about 13% of its total revenue. Hence, the appellant's selection of the AE as tested party was flawed, and the TPO's rejection was upheld.

Issue 2: Use of Multiple Year Data for Selection of Comparables

Rule 10B(4) of the Income Tax Rules stipulates that data relating to the financial year in which the transaction occurred shall be used for comparability analysis, with a proviso allowing consideration of data from up to two preceding years if such data reveals facts influencing transfer price determination. The 2010 OECD Guidelines (paras 3.75 to 3.79) recognize that multiple year data can be useful but is not mandatory, and its use should be justified by added value to the analysis.

The appellant argued that due to business cycles, industry profile, and economic conditions, averaging three years' data was appropriate to avoid distortions from abnormal factors. The TPO and the Tribunal, however, held that the appellant failed to demonstrate any specific rationale or facts necessitating the use of multiple year data. Moreover, the proviso allowing prior years' data was rendered inapplicable for transactions entered on or after April 1, 2014, by amendment. Since the appellant's transaction fell after this date, the use of multiple year data was not permitted as a matter of law. The Tribunal thus upheld the TPO's rejection of multiple year data and directed reliance on contemporaneous data only.

Issue 3 and 4: Selection and Rejection of Comparables

The appellant challenged the TPO's rejection of two comparables-Consolidated Construction Consortium Ltd. and Shriram EPC Ltd.-alleging that the rejection was based solely on their financial losses during the relevant period, which was not a valid criterion under Rule 10B(2). The appellant contended these companies were functionally similar to the AE and should have been accepted.

The TPO countered that the rejection was based on functional dissimilarity, not merely financial performance. Shriram EPC Ltd. was engaged in environmental projects dissimilar to civil construction, and Consolidated Construction Consortium Ltd. was also found functionally different based on available public domain data. The Tribunal agreed with the TPO's reasoning, emphasizing that functional comparability is paramount in transfer pricing analysis, and rejected the appellant's contention.

Regarding the addition of new comparables by the TPO, the appellant alleged that these were introduced without proper disclosure or backup, causing hardship. The TPO demonstrated that these comparables were identified from the appellant's own TP study report and had been previously rejected by the appellant on grounds of functional dissimilarity. The Tribunal found no merit in the appellant's claim, noting that the appellant had access to all relevant data and had been given adequate opportunity to respond. The addition of these comparables was deemed lawful and appropriate.

Issue 5: Treatment of Ashoka Highways (Durg) Ltd. as Comparable

Ashoka Highways (Durg) Ltd., one of the comparables added by the TPO, had an exceptionally high operating margin of 38%, primarily because during the relevant year it was engaged in toll operation rather than construction activity. The appellant argued that its business model and revenue source were not comparable to the appellant JV's construction services, making it an unsuitable comparable.

The Tribunal accepted this argument and directed the exclusion of Ashoka Highways (Durg) Ltd. from the comparable set. The ALP was to be recomputed excluding this outlier, using the remaining comparables, which were otherwise found functionally similar and appropriate.

Conclusions and Significant Holdings

The Tribunal upheld the TPO's rejection of the AE as the tested party, affirming that the tested party should be the entity with the least complex functional and risk profile and for which reliable data is available. It was held that the appellant JV, performing limited functions and deriving all income from the specified domestic transaction, was the appropriate tested party under TNMM. The Tribunal emphasized:

"The tested party normally should be the party in respect of which reliable data for comparison is easily and readily available and fewest adjustments in computations are needed... The selection of tested party is to further the object of comparability analysis by making it less complex and requiring fewer adjustments."

The Tribunal also confirmed the statutory and jurisprudential position that contemporaneous data should be used for comparability analysis, and multiple year data is permissible only under specific conditions, which were not demonstrated by the appellant. It was noted that the proviso allowing prior years' data was inapplicable for transactions after April 1, 2014.

Regarding comparables, the Tribunal endorsed the TPO's functional analysis in rejecting comparables that were functionally dissimilar, irrespective of their financial performance. The addition of new comparables from the appellant's own TP study report was found to be proper and within the procedural safeguards provided by the law.

Finally, the Tribunal recognized the inappropriateness of including an outlier comparable engaged primarily in toll operations with an inflated margin and directed its exclusion for recalculation of the ALP.

The appeal was partly allowed on statistical grounds to exclude the outlier comparable, with all other grounds dismissed. The ALP was to be recomputed accordingly by the Assessing Officer.