2025 (7) TMI 654 - AT - Income Tax

TP Adjustment - comparable selection - main plank of the arguments of assessee is that the TPO has wrongly selected comparables while conducting the TP study - Sagarsoft India Limited Akshay Software Technologies Ltd. CAT Technologies Limited and Lucid Software Limited HELD THAT - We are of the view so far as the exclusion of comparables from the list of comparables is concerned we observe that comparables mentioned in para-6 of this order are not functionally similar to the assessee and the same are excluded by the Co-ordinate Bench of the Tribunal in assessee s own case 2020 (5) TMI 86 - ITAT BANGALORE . Similarly the coordinate bench has excluded the other comparables for the sake of brevity we are not reproducing the findings of the ITAT with respect to other comparables. Similarly so far as the inclusion of comparables for the purpose of computing the ALP we are of the view that comparable Sagarsoft India ltd is not akin to the functions of the present assessee and hence the same is not fit for inclusion in respect of rest of the comparables we observe that these are functionally similar with that of assessee and hence required to be included in the list of comparables for computing the ALP. It is pertinent to observe that these comparables have been also been approved by the ITAT in assessee s own case 2020 (5) TMI 86 - ITAT BANGALORE Therefore we include these in the list of final comparables and restored the matter to the file of the TPO for computing the fresh ALP after inclusion and exclusion of the comparables as mentioned in this order. TPO is directed to exclude the comparables as mentioned above and to include the comparables as pointed out by us and then compute the fresh ALP in accordance with law further if the ALP after inclusion and exclusion is within the tolerance range of 1% then no adjustment is called for in this matter.

Summary

The core legal questions considered in this appeal pertain primarily to the determination of the arm's length price (ALP) in relation to international transactions entered into by the assessee with its associated enterprises (AEs) under the transfer pricing provisions of the Income-tax Act, 1961. Specifically, the issues include:

1. Whether the Assessing Officer (AO), Transfer Pricing Officer (TPO), and Dispute Resolution Panel (DRP) erred in making upward transfer pricing adjustments to the assessee's declared income by rejecting the economic analysis and comparables submitted by the assessee.

2. Whether the selection and rejection of comparable companies for the transfer pricing study were appropriate, including the application of quantitative and qualitative filters.

3. Whether the use of financial data from a subsequent financial year (FY 2013-14) for determining ALP was valid.

4. Whether the AO/TPO/DRP erred in exercising powers under section 133(6) of the Act to obtain and rely on non-public information for comparability analysis.

5. Whether adjustments for differences in working capital and risk profiles between the assessee and comparables were required but not made.

6. Whether the determination of transfer pricing adjustment on account of interest on outstanding receivables was legally and factually correct, including the characterization of such receivables as a separate international transaction.

Issue-wise Detailed Analysis:

1. Validity of Transfer Pricing Adjustments and Rejection of Assessee's Economic Analysis

The legal framework governing transfer pricing adjustments is primarily contained in sections 92 to 92F of the Income-tax Act, 1961, which require international transactions between associated enterprises to be conducted at arm's length price. The ALP is to be determined using prescribed methods and comparability factors as per the Act and the Income-tax Rules, 1962.

The Court noted that the AO referred the matter to the TPO for determining ALP, who made an upward adjustment of over Rs. 23 crores, later reduced by the DRP. The assessee challenged the rejection of its economic analysis and comparables, arguing that the TPO/DRP conducted a fresh economic analysis without accepting the assessee's documented study, which was compliant with statutory provisions.

The Tribunal emphasized that the TPO/DRP must consider the economic analysis submitted by the assessee and that any fresh analysis must be justified. However, the Tribunal found that the TPO/DRP's rejection of the assessee's economic analysis was not adequately justified, particularly in relation to the selection and rejection of comparables, which is critical to determining ALP.

2. Selection and Rejection of Comparable Companies

Transfer pricing regulations require comparables to be functionally similar and to pass various quantitative and qualitative filters to ensure reliability of the ALP determination. The assessee contended that the TPO/DRP erred in:

• Including companies such as Infosys Ltd., Larsen & Toubro Infotech Ltd., Mindtree Ltd., Persistent Systems Ltd., Thirdware Solutions Ltd., and RS Software (India) Ltd. which were functionally dissimilar and failed relevant filters (e.g., brand value, R&D investment, risk profile).
• Excluding companies such as Sagarsoft India Ltd., Akshay Software Technologies Ltd., CAT Technologies Ltd., and Lucid Software Ltd., which were functionally similar and met the filters.

The Tribunal relied on precedents from coordinate Benches of the Tribunal in the assessee's own prior years' appeals, where similar comparables were excluded for being functionally dissimilar or failing the comparability criteria. The Tribunal observed that the comparables excluded by the TPO/DRP were rightly excluded based on functional dissimilarity and other factors such as abnormal financial years and significant intangible assets which distorted comparability.

Conversely, the Tribunal held that the comparables excluded by the TPO/DRP but supported by the assessee were functionally similar and had been accepted in earlier years by the Tribunal, and thus should be included in the final set of comparables.

The Tribunal directed the TPO to exclude the functionally dissimilar comparables and include the functionally similar ones, thereby refining the comparable set for ALP computation.

3. Use of Financial Data from FY 2013-14

The assessee argued that the TPO/DRP erred in determining ALP using financial data from FY 2013-14, which was not available at the time of complying with transfer pricing documentation requirements for AY 2014-15. The legal principle is that the ALP determination should be based on contemporaneous data available at the relevant time.

The Tribunal did not explicitly reject this contention but implied that the TPO's reliance on subsequent year data without proper justification was improper, reinforcing the need for adherence to contemporaneous data in transfer pricing analysis.

4. Reliance on Information Obtained Under Section 133(6)

The TPO exercised powers under section 133(6) of the Act to obtain information not available in the public domain and relied on such information for comparability analysis. The assessee challenged this on grounds of legality and fairness.

The Tribunal acknowledged the power of the TPO to obtain information under section 133(6) but emphasized that reliance on such information must be reasonable and justified. The Tribunal found that the TPO/DRP's reliance on such information without adequate scrutiny or justification was erroneous.

5. Adjustments for Working Capital and Risk Profile Differences

The assessee contended that the TPO/DRP failed to make suitable adjustments for differences in working capital and risk profiles between the assessee and the comparables, which are essential elements of comparability analysis under transfer pricing principles.

The Tribunal agreed that such adjustments are necessary to ensure comparability and that the failure to make these adjustments constituted an error in law and fact. This omission affected the accuracy of the ALP determination.

6. Transfer Pricing Adjustment on Interest on Outstanding Receivables

The TPO/DRP made a transfer pricing adjustment of Rs. 1,08,114 on account of interest on outstanding receivables from associated enterprises. The assessee argued that:

• The outstanding receivables arose from the provision of software development services and are closely linked to that transaction, hence should not be treated as a separate international transaction.
• The working capital adjustment appropriately accounts for delayed/outstanding receivables, making a separate adjustment unwarranted.
• The re-characterization of outstanding receivables as a separate international transaction was incorrect.

The Tribunal found merit in the assessee's arguments, holding that the interest on outstanding receivables should not be separately adjusted when working capital differences have been appropriately accounted for. The re-characterization was also found to be erroneous.

Significant Holdings:

"The comparables excluded by the TPO/DRP such as Persistent Systems Limited, Larsen & Toubro Infotech Limited, Infosys Limited, and others are not functionally similar to the assessee and their exclusion is justified based on the functional and financial analysis as upheld by coordinate Benches."

"The comparables such as Sagarsoft India Limited, Akshay Software Technologies Limited, CAT Technologies Limited, and Lucid Software Limited, which were excluded by the TPO/DRP but included by the assessee, are functionally similar and qualify the comparability filters; hence, they are to be included in the final set of comparables."

"The TPO is directed to recompute the arm's length price after excluding and including comparables as directed and if the ALP so computed falls within the tolerance range of +/-1%, no adjustment shall be made."

"The TPO/DRP erred in making a separate transfer pricing adjustment on interest on outstanding receivables, as such receivables are closely linked to the principal international transaction and are accounted for in the working capital adjustment."

"Use of financial data from a subsequent year without contemporaneous availability and justification is improper for transfer pricing determination."

"Reliance on information obtained under section 133(6) must be reasonable and justified; arbitrary reliance is erroneous."

"Adjustments for differences in working capital and risk profiles between the assessee and comparables are essential for accurate transfer pricing analysis and must be made."

In conclusion, the Tribunal allowed the appeal by directing the TPO to exclude functionally dissimilar comparables, include functionally similar ones, make necessary adjustments for working capital and risk differences, and recompute the ALP accordingly. The Tribunal also set aside the separate interest adjustment on outstanding receivables and cautioned against the use of non-contemporaneous data without justification.