2023 (4) TMI 1416 - AT - Income Tax

TP adjustment - exclusion of comparables as contended by the assessee - HELD THAT - Infosys BPM is having a huge brand value and higher turnover. On the other hand when the assessee is providing BPO services itself and only doing the actual work based on specifications provided by its AEs it is nothing compared to the brand value of the Infosys BPM and neither the assessee is a market leader nor is having high turnover we direct the A.O/T.P.O to exclude Infosys BPM from the final set of comparables while bench marking international transactions of the assessee company. MPS Ltd.is providing publishing solutions to its clients and there have been several acquisitions also. This extraordinary event itself by way of several acquisitions renders this company as non-comparable with that of the assessee. In view of the factual and legal analysis we direct the A.O/T.P.O to exclude MPS Ltd. from the final set of comparables while bench marking international transactions of the assessee company.

Summary

1. ISSUES PRESENTED and CONSIDERED

The core legal questions considered by the Tribunal in this appeal arising from transfer pricing adjustments for Assessment Year 2016-17 include:

• Whether the Assessing Officer (AO) erred in making a transfer pricing addition of Rs. 68,35,68,248 and raising a demand of Rs. 37,37,80,120;
• Whether the Transfer Pricing Officer (TPO) and Dispute Resolution Panel (DRP) erred in rejecting the appellant's benchmarking analysis and independently determining the arm's length price (ALP) without fulfilling jurisdictional preconditions under section 92C(3) of the Income Tax Act;
• Whether the TPO/DRP erred in modifying the filters and rejecting all comparable companies identified by the appellant in its transfer pricing study;
• Whether the TPO/DRP erred in selecting comparables without proper search criteria and on an ad hoc basis;
• Whether Infosys BPM Ltd. and MPS Ltd. ought to have been excluded from the final set of comparables based on functional differences and market position;
• Whether R Systems International Limited and other companies were improperly excluded from the comparable set;
• Whether risk adjustments should have been allowed to reflect differing risk profiles between the appellant and comparables;
• Whether the variation in service fees charged by the appellant to associated enterprises was within the permissible range under the second proviso to section 92C(2), thus negating the need for adjustment;
• Whether the Advance Pricing Agreement (APA) between the appellant and the CBDT, though not applicable to the year under consideration, precluded transfer pricing adjustments given the variation was within +/- 3%;
• Whether education cess on income tax should be allowed as a deductible expense;
• Whether penalty proceedings under sections 274 read with 271(1)(c) were rightly initiated given the difference was a matter of opinion on arm's length price computation;
• General grounds for amendment or addition to appeal grounds.

2. ISSUE-WISE DETAILED ANALYSIS

Exclusion of Infosys BPM Ltd. and MPS Ltd. as Comparables

The appellant pressed for exclusion of only two comparables, Infosys BPM Ltd. and MPS Ltd., contending that their exclusion would bring the transfer pricing adjustment within permissible limits, rendering other grounds academic.

Legal Framework and Precedents: The determination of comparables in transfer pricing must be based on functional comparability, considering functions performed, assets employed, and risks assumed. The principle of consistency and judicial precedents on the non-comparability of entities with extraordinary events or significantly different market positions are relevant. The Hon'ble Bombay High Court's ruling in the appellant's own case held that the appellant provides BPO (Business Process Outsourcing) services and not KPO (Knowledge Process Outsourcing) services, which is critical in assessing functional comparability.

Court's Interpretation and Reasoning: The Tribunal examined the functional analysis of the appellant, confirming that it provides BPO services to its associated enterprises (AEs) and does not engage in KPO activities. This was supported by the Bombay High Court's decision emphasizing the appellant's BPO function. The Tribunal noted that Infosys BPM Ltd. is a market leader with significant brand value and higher turnover, which renders it functionally different and non-comparable to the appellant. Additionally, Infosys BPM had undergone extraordinary events such as the acquisition of McCamish Systems LLC, affecting its financial margins.

Similarly, MPS Ltd. was found to be functionally different. It is primarily an e-publishing company providing end-to-end publishing solutions, including typesetting, data digitization, content and product development, which are akin to IT services or KPO rather than BPO. The company also underwent multiple acquisitions, constituting extraordinary events. The Tribunal relied on earlier decisions by coordinate Benches of the Tribunal excluding MPS Ltd. from comparable sets on these grounds.

Key Evidence and Findings: The Tribunal relied on the appellant's transfer pricing study, the TPO's orders, annual reports of Infosys BPM and MPS Ltd., and prior judicial decisions. The appellant's consistent exclusion of Infosys BPM in earlier years (AYs 2010-11, 2014-15, 2017-18) was noted, with the TPO accepting the ALP without including Infosys BPM as comparable. The extraordinary events affecting both companies and their functional dissimilarity to the appellant were established.

Application of Law to Facts: The Tribunal applied the principle that comparability requires similarity in functions, risks, and assets, and companies with extraordinary events or significantly different market positions cannot be comparables. The appellant's BPO-only function contrasted with the KPO/IT services nature and market leadership of the two companies. The Tribunal emphasized consistency in treatment across assessment years.

Treatment of Competing Arguments: The Departmental Representative (D.R.) did not refute the appellant's evidence or produce any contrary order or material. The D.R. conceded the Bombay High Court's decision on the appellant's functional profile and relied on subordinate authorities' orders. The Tribunal found the appellant's submissions and supporting precedents more persuasive.

Conclusions: Infosys BPM Ltd. and MPS Ltd. are functionally different and non-comparable to the appellant. The Tribunal directed the AO/TPO to exclude these two companies from the final set of comparables in benchmarking international transactions.

Effect of Excluding Infosys BPM Ltd. and MPS Ltd. on Other Grounds

The appellant contended that excluding these two comparables would bring the transfer pricing adjustment within the permissible +/- 5% range, rendering other grounds (1, 2, 3, 4, 6, 7, 8, 9, and 10) academic.

The Tribunal accepted this submission, holding that once Infosys BPM and MPS Ltd. are excluded, the other grounds concerning benchmarking methodology, risk adjustment, jurisdictional preconditions, and application of APA provisions need no further adjudication.

Other Grounds

Ground No. 5 was partly allowed as above. Ground No. 11 (education cess deduction) was not pressed by the appellant and dismissed. Ground No. 12 (initiation of penalty proceedings) was held premature and not adjudicated. Ground No. 13 was general and not specifically addressed.

3. SIGNIFICANT HOLDINGS

The Tribunal held:

"We are of considered view, therefore, and considering all these parameters Infosys BPM is held functionally different and not comparable on the functional basis with the assessee since Infosys BPM is having a huge brand value and higher turnover. On the other hand, when the assessee is providing BPO services itself and only doing the actual work based on specifications provided by its AEs it is nothing compared to the brand value of the Infosys BPM and neither the assessee is a market leader nor is having high turnover, we direct the A.O/T.P.O to exclude Infosys BPM from the final set of comparables while bench marking international transactions of the assessee company."

"Having gone through the annual report of the company, findings of the Subordinate Authorities and the submissions of the assessee placed on record along with judicial pronouncements, it is evident that MPS Limited is functionally different from that of the assessee company in more-so that high end activities of MPS Ltd is akin to IT services and not ITes. Respectfully following the decision of the Co-ordinate Bench of the Tribunal (supra.) we direct the AO/TPO to exclude MPS Limited from final list of comparable companies."

The Tribunal's core principles established include:

• Functional comparability is paramount in selecting comparables for transfer pricing analysis;
• Companies with extraordinary events such as acquisitions or mergers affecting financials are not appropriate comparables;
• Market leadership and brand value differences are material in assessing comparability;
• Consistency in treatment of comparables across assessment years is important;
• Where exclusion of certain comparables brings the ALP within permissible ranges, further disputes on benchmarking methodology become academic.

Final determination was that the AO/TPO must exclude Infosys BPM Ltd. and MPS Ltd. from the comparable set, and accordingly, the appeal was partly allowed with other grounds rendered academic.