2023 (10) TMI 1526 - AT - Income Tax

TP adjustment - comparables selected by the AO and seeking exclusion of the same - HELD THAT - MPS Ltd. is engaged in software products also like typesetting and data digitalization services etc. Further the Co-ordinate Bench held that there was no segmental information relating to ITES services and in the absence of such information held the same is not comparable to that of assessee s functions. We find the facts and circumstances for A.Y. 2014-15 and in the year under consideration is similar and identical and by following the same we direct the TPO to exclude the MPS Ltd. as comparable company. Domex E-Data Pvt. Ltd. is not comparable and directed the TPO to exclude the same to the final list of comparables. CES Ltd. is not comparable and we direct the TPO to exclude the said company from the final list of comparables. Appeal of assessee is allowed.

Summary

The core legal questions considered in this appeal relate primarily to the determination of appropriate comparables for transfer pricing adjustment under the Income Tax Act, specifically for international transactions involving information technology enabled services (ITES). The key issues include:

1. Whether certain companies selected by the Assessing Officer (AO) and Transfer Pricing Officer (TPO) as comparables for benchmarking international transactions are, in fact, comparable to the assessee's functions and business profile.

2. The validity of including or excluding specific companies-namely MPS Ltd., Domex E-Data Pvt. Ltd., and CES Ltd.-from the final list of comparables used for determining the arm's length price (ALP).

3. The implications of excluding these companies on the transfer pricing adjustment and the consequent necessity to adjudicate other grounds of appeal.

4. The premature challenge to the penalty levied under section 270A of the Income Tax Act.

Issue-wise Detailed Analysis:

1. Comparability of Selected Companies for Transfer Pricing Adjustment

The legal framework governing transfer pricing under the Income Tax Act mandates that international transactions between associated enterprises be benchmarked against comparable uncontrolled transactions to determine the arm's length price. The Transfer Pricing Officer (TPO) and Assessing Officer (AO) are required to select comparables that are functionally similar to the assessee's international transactions.

The assessee, engaged solely in providing IT enabled services (ITES), adopted the Transactional Net Margin Method (TNMM) and selected a set of comparables to establish its Profit Level Indicator (PLI) at 14.33%. The TPO rejected several of these and included others, resulting in a higher PLI of 26.56%. The AO finalized a list of 11 comparables, including CES Ltd., Access Healthcare Services Pvt. Ltd., Domex E-Data Pvt. Ltd., and MPS Ltd., which the assessee contested.

a) MPS Ltd.

Precedent from the Tribunal's earlier decision for AY 2014-15 was pivotal. The Tribunal analyzed MPS Ltd.'s annual report and noted that the company was engaged not only in ITES but also in software products such as typesetting and data digitalization. The absence of segmental information specifically relating to ITES services rendered MPS Ltd. functionally dissimilar to the assessee, which exclusively provided ITES. The Tribunal emphasized that comparability requires similarity in functional profiles, and in the absence of segmental data isolating ITES activities, MPS Ltd. could not be considered comparable.

The Court applied this reasoning to the present year, observing that the facts and circumstances remained consistent. Following the principle of functional comparability and segmental clarity, the Tribunal directed exclusion of MPS Ltd. from the list of comparables.

b) Domex E-Data Pvt. Ltd.

The assessee relied on a coordinate bench decision in the case of Katerra Technology Services for AY 2018-19, which excluded Domex E-Data Pvt. Ltd. from comparables. The Tribunal noted that Domex engaged in software development using advanced software and hardware, product innovation, and renovation activities, which are functionally distinct from the assessee's ITES functions.

The Tribunal referenced the Schlumberger India Technology Centre decision, which held that KPO (Knowledge Process Outsourcing) and ITeS are not interchangeable for comparability purposes. It was noted that Domex's involvement in diversified activities, including software development and KPO services, rendered it functionally dissimilar to the assessee's ITES-only business. The revenue authorities' inclusion of Domex based solely on its e-commerce activities was found insufficient, as they failed to analyze the full scope of Domex's functions.

Consequently, the Tribunal directed the exclusion of Domex E-Data Pvt. Ltd. from the final comparables list, reinforcing the principle that comparability requires detailed functional analysis beyond broad sector classification.

c) CES Ltd.

The assessee challenged CES Ltd.'s inclusion on the ground that it provided both BPO and KPO services, while the assessee was engaged only in ITES (specifically BPO-type services such as translation). The Tribunal referred to its earlier decisions, including Transperfect Solutions India Pvt. Ltd. and Credence Resource Management Pvt. Ltd., which held that companies engaged in both BPO and KPO services cannot be considered comparable to entities engaged exclusively in BPO/ITES.

The Tribunal examined CES Ltd.'s annual report, confirming its dual engagement in KPO and BPO. Given the functional dissimilarity, CES Ltd. was directed to be excluded from the comparables.

Application of Law to Facts and Treatment of Competing Arguments

The Tribunal consistently applied the principle of functional comparability, requiring that comparables be similar in the nature of services rendered, business activities, and segmental operations. The Tribunal rejected the revenue authorities' reliance on broad industry classification or selective activities without thorough functional analysis.

The assessee's argument that excluding MPS Ltd., Domex E-Data Pvt. Ltd., and CES Ltd. would bring the PLI within the acceptable range was accepted, rendering further examination of other comparables and additional grounds academic. The Tribunal emphasized adherence to precedents and detailed scrutiny of annual reports and segmental disclosures to ensure comparability.

2. Penalty under Section 270A

The assessee's challenge to the penalty levied under section 270A was dismissed as premature, reflecting the principle that penalty proceedings should be adjudicated only after finalization of the assessment and related issues.

Significant Holdings:

"In the absence of any segmental information relating to ITES, this company loses comparability with the assessee company, which is engaged in rendering only ITES. We, therefore, direct to exclude this company from the list of comparables." (Regarding MPS Ltd.)

"Domex e-Data Pvt. Ltd. is a company engaged in various activities including software development KPO & BPO services and, hence, is functionally dissimilar to the functions of ITeS carried out by the assessee."

"CES Limited providing both BPO and KPO services, cannot therefore be held as comparable with an assessee engaged only in BPO/ITES services."

"When the revenue authorities have not specifically examined and brought out why a particular company in the ITeS segment is specifically similar with that of the functions performed by the assessee and when the reason for inclusion of such comparable has not been analyzed with regard to the specific business, in such case, we are of the considered view... this company is functionally dissimilar with that of the assessee company."

The Tribunal established the core principle that comparability for transfer pricing purposes requires a detailed functional analysis, including examination of segmental information, nature of services, and business activities. Broad industry classification or partial functional similarity is insufficient to establish comparability.

Accordingly, the Tribunal directed the exclusion of MPS Ltd., Domex E-Data Pvt. Ltd., and CES Ltd. from the final list of comparables, thereby allowing the assessee's appeal and negating the transfer pricing adjustment premised on these comparables. The penalty challenge was dismissed as premature.