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2025 (6) TMI 1623 - AT - Income Tax


The core legal questions considered by the Tribunal in this appeal pertain primarily to the correctness and legality of transfer pricing adjustments made by the Assessing Officer (AO) and Transfer Pricing Officer (TPO) under the Income Tax Act, 1961, specifically for the assessment year 2017-18. The issues revolve around:

(i) The validity and correctness of the transfer pricing adjustment made on international transactions involving software development services (SDS) provided by the assessee company to its Associated Enterprises (AEs), including the selection and treatment of comparable companies in benchmarking the arm's length price (ALP).

(ii) The appropriateness of the transfer pricing adjustment on interest paid by the assessee on Indian Rupee denominated External Commercial Borrowings (INR ECB) from its AE, particularly the method and benchmark used for determining arm's length interest rate.

(iii) The rejection of the transfer pricing documentation maintained by the assessee and the alleged "cherry picking" of comparables by the TPO/AO/Dispute Resolution Panel (DRP).

(iv) The inclusion and exclusion criteria applied for selecting comparable companies, including the application of turnover filters, treatment of companies with persistent losses, and consideration of functional comparability factors.

(v) The denial of working capital adjustment and risk adjustment in the transfer pricing analysis.

(vi) The correctness of the AO's computation of tax demand, specifically regarding the grant of advance tax credit and consequential interest liability under sections 234B and 234D of the Act.

Issue-wise Detailed Analysis:

1. Transfer Pricing Adjustment on Software Development Services (SDS) and Selection of Comparables

Legal Framework and Precedents: Transfer pricing provisions under Sections 92CA and related rules require benchmarking international transactions at arm's length price. The selection of comparables must be functionally comparable and reflect similar risk profiles and economic circumstances. Judicial precedents emphasize the importance of applying appropriate filters, including turnover filters, to exclude companies that are not truly comparable due to size, brand value, or functional differences.

Court's Interpretation and Reasoning: The Tribunal examined the list of comparables selected by the TPO, noting that five companies-Infosys Ltd., Wipro Ltd., Larsen & Toubro Infotech Ltd., Mindtree Ltd., and Tata Elxsi Ltd.-were included despite having turnovers exponentially higher than the assessee company (turnover of approximately Rs. 25.56 crore versus turnovers ranging from Rs. 1,233.6 crore to Rs. 59,289 crore). The Tribunal agreed with the assessee's contention that these companies, being market leaders with significant brand value, economies of scale, and diverse service offerings, are functionally dissimilar to the assessee, a smaller SDS provider.

The Tribunal relied on authoritative judicial pronouncements from various High Courts and ITAT benches, which consistently held that comparables with substantially higher turnovers and different risk profiles should be excluded. Notably, the Bombay High Court in CIT vs. Pentair Water India (P) Ltd, the Punjab & Haryana High Court in Principal Commissioner of Income Tax vs. Equant Solutions India (P.) Ltd, and the Delhi High Court in Principal Commissioner of Income Tax vs. Freescale Semiconductor India (P.) Ltd, all underscored the necessity of applying turnover filters to ensure comparability.

Key Evidence and Findings: The turnover disparity and the nature of business activities of the five comparables were critical factors. The Tribunal found that the TPO/DRP erred in not applying a turnover filter and in including these companies, leading to an inflated profit margin benchmark and consequently an unwarranted transfer pricing adjustment of Rs. 1,60,72,299.

Application of Law to Facts and Treatment of Competing Arguments: While the Departmental Representative contended that the comparables were functionally comparable and that turnover differences alone should not exclude them, the Tribunal emphasized that turnover is a significant indicator of functional risk and scale of operations, which impacts profitability. The Tribunal directed the TPO to exclude these five comparables and conduct a fresh search applying a turnover filter of ten times on both ends to identify suitable comparables.

Conclusion: The Tribunal held that the inclusion of the five comparables was erroneous and directed re-benchmarking excluding these companies, thus setting aside the transfer pricing adjustment on SDS to that extent.

2. Transfer Pricing Adjustment on Interest Paid on INR Denominated External Commercial Borrowings (ECB)

Legal Framework and Precedents: Transfer pricing on interest payments under international transactions requires benchmarking the interest rate at arm's length, considering the currency of the loan, risk borne by the borrower and lender, and the appropriate method (such as the Comparable Uncontrolled Price (CUP) method). The currency risk borne by the parties is a critical factor in determining comparability.

Court's Interpretation and Reasoning: The assessee had benchmarked the interest paid on the INR-denominated ECB by comparing it to the State Bank of India Prime Lending Rate (SBI-PLR), which was higher (13.75%) than the actual interest rate paid (10.45%). The TPO rejected this benchmarking, holding that since the loan was denominated in Indian Rupees and repayable in Indian Rupees, it was akin to a "Masala Bond" transaction, and therefore the interest rate should be benchmarked against publicly available Masala Bond rates (7.48% to 7.875%). This resulted in a transfer pricing adjustment of Rs. 4,70,287, upheld by the DRP.

The Tribunal analyzed the nature of Masala Bonds, noting that while foreign investors bear currency risk, the Indian borrower's liability is fixed in Indian Rupees, insulating the borrower from currency fluctuations. Consequently, the risk profile of the borrower on an INR-denominated ECB is similar to a domestic Indian rupee loan, not a foreign currency loan.

The Tribunal relied on the ITAT Hyderabad Bench decision in Adama India Pvt Ltd vs. ITO and the Special Bench decision in Invesco (India) Private Limited vs. DCIT, which emphasized that the currency of the loan and the currency risk borne by the borrower are pivotal in selecting the benchmark. For INR-denominated loans, domestic lending rates are the appropriate comparables, not foreign currency or Masala Bond rates.

Key Evidence and Findings: The Tribunal found the SBI-PLR to be a more appropriate benchmark for the interest rate on the INR-denominated ECB, as it reflects the domestic cost of funds and risk profile.

Application of Law to Facts and Treatment of Competing Arguments: The Departmental Representative's argument that the ECB was a Masala Bond transaction and should be benchmarked accordingly was rejected. The Tribunal held that the borrower's perspective and liability currency are determinative factors, and since the liability was in Indian Rupees, domestic rates govern the arm's length price.

Conclusion: The Tribunal set aside the transfer pricing adjustment of Rs. 4,70,287 on interest paid on the INR-denominated ECB, directing the AO/TPO to vacate the adjustment.

3. Rejection of Transfer Pricing Documentation and Alleged Cherry Picking of Comparables

The assessee contended that the TPO/AO/DRP erred in rejecting the transfer pricing documentation prepared in accordance with the Act and Rules, and in undertaking a fresh economic analysis during assessment proceedings, resulting in arbitrary adjustments. The Tribunal noted these contentions but focused its analysis on the core issue of comparability and benchmarking rather than procedural improprieties. The Tribunal implicitly recognized the importance of adherence to prescribed documentation and cautioned against selective or "cherry picking" of comparables, as reflected in its direction to apply consistent filters and conduct a fresh search for comparables.

4. Inclusion and Exclusion of Comparable Companies and Application of Filters

The Tribunal dealt extensively with the inclusion of companies with high turnover and the exclusion of certain companies proposed by the assessee as comparables but rejected by the TPO/AO/DRP. The Tribunal emphasized the need for functional comparability, considering factors such as intangible assets, intellectual property, advertising expenses, brand presence, and turnover. It held that companies with persistent losses or significantly different operational profiles should be excluded.

Specifically, the Tribunal directed that turnover filters be applied symmetrically (ten times on both ends) and that companies functionally comparable to the assessee be included. It also noted that persistent loss filters must be applied correctly and consistently.

5. Risk Adjustment and Working Capital Adjustment

The assessee claimed that the TPO/AO/DRP erred in disregarding the risk profile differences between the assessee and comparables and in not granting working capital adjustment. While these issues were raised, the Tribunal's order does not record detailed findings on these points, indicating that they may be addressed during the reassessment process following the fresh benchmarking directed.

6. Advance Tax Credit and Interest Liability Computation

The assessee contended that the AO erred in not granting advance tax credit while computing tax demand and related interest under sections 234B and 234D. The Tribunal directed the AO to verify the claim and grant credit if found in order, in accordance with law.

Significant Holdings:

"We concur with the Ld. AR that the aforementioned five (5) comparable selected by the TPO having exceptionally high turnovers are typically the market leaders possessing significant brand value, economies of scale and access to advanced technology and larger client basis, which, thus, fundamentally differentiates them from a smaller or medium sized company like the assessee company before us."

"The Courts/ Tribunals have consistently emphasized the relevance and the applicability of the 'turnover filter', specifically in a case where there is a substantial difference in the turnover of the assessee and the selected comparables, indicating a difference in their functional risk profiles."

"We are of the firm conviction that the risk profile of the borrower in Indian rupee denominated ECB is similar to a domestic Indian rupee loan and cannot be equated with a foreign currency loan."

"We thus, are of the firm conviction that as the assessee company had benchmarked its interest payment on INR denominated ECB of 10.45% against SBI-PLR of 13.75%, therefore, the same based on our aforesaid observations read along with the judicial pronouncements can safely be held to be within Arm's Length."

"We direct the TPO/ DRP to exclude the aforesaid five comparables from the final list of comparables. With this view of the matter, we direct the TPO/AO to take the range of turnover filter at ten times on both the ends and conduct afresh search to arrive at a plausible view."

"Accordingly, we direct the AO/ TPO to vacate the TP adjustment of Rs. 4,70,287/- qua the interest paid by the assessee company on the INR denominated ECB to its AE."

The Tribunal's final determinations were that the transfer pricing adjustment on software development services must be revisited after excluding the five large turnover comparables and applying appropriate turnover filters; the transfer pricing adjustment on interest paid on INR-denominated ECBs was not justified and must be vacated; and the AO must verify and grant advance tax credit if due. The appeal was allowed accordingly.

 

 

 

 

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