2025 (7) TMI 962 - AT - Income Tax

TP Adjustment - comparable selection - HELD THAT - We direct the AO to exclude Infosys Limited from the list of final set of comparables as functionally dissimilar for the purpose of computing ALP of international transactions of the appellant-company with it s AEs.

Summary

1. ISSUES PRESENTED and CONSIDERED

The core legal questions considered by the Tribunal in this appeal pertain primarily to transfer pricing adjustments under the Income Tax Act, 1961. The main issues are:

• Whether the upward transfer pricing adjustment of INR 2,70,56,964 made by the Assessing Officer (AO)/Transfer Pricing Officer (TPO)/Dispute Resolution Panel (DRP) on international transactions relating to provision of IT services to Associated Enterprises (AEs) is justified and in accordance with law.
• Whether the AO/TPO/DRP erred in rejecting the transfer pricing documentation and benchmarking analysis prepared by the appellant, including the selection and rejection of comparable companies.
• Whether the AO/TPO/DRP erred in applying inappropriate qualitative and quantitative filters in the selection of comparable companies, including filters related to export earnings, software development income, financial year data availability, related party transactions, and abnormal margins.
• Whether the inclusion of certain companies, notably Infosys Limited, as comparable companies was appropriate given their functional and risk profiles compared to the appellant company.
• Whether the AO erred in initiating penalty proceedings under sections 270A read with 274 of the Income Tax Act.

2. ISSUE-WISE DETAILED ANALYSIS

Transfer Pricing Adjustment and Comparable Companies Selection

Relevant Legal Framework and Precedents: The transfer pricing provisions under sections 92C, 92CA, 143(3), 144B, 144C of the Income Tax Act, 1961 govern the determination of arm's length price (ALP) for international transactions between associated enterprises. The Transfer Pricing Officer (TPO) is empowered to examine and determine ALP, including selection of comparable companies using methods such as the Transactional Net Margin Method (TNMM) as the Most Appropriate Method (MAM). The DRP has the authority to review draft assessment orders and issue directions. Precedents include prior decisions of the Tribunal, notably the appellant's own case for AY 2014-15 and decisions in cases such as ADP Pvt. Ltd. v. DCIT.

Court's Interpretation and Reasoning: The Tribunal examined the functional profiles, risk profiles, and business models of the appellant and the comparable companies selected by the AO/TPO/DRP. The appellant company is a captive service provider to its AEs on a cost plus basis, providing software development services without significant marketing, R&D, or brand presence. In contrast, companies like Infosys Limited have diversified business operations, substantial brand value, significant R&D expenditure, and engage in sale of licenses and products, which materially affect their operating margins.

The Tribunal noted that the AO/TPO/DRP had rejected the appellant's benchmarking analysis and selected a fresh set of comparable companies by applying additional filters and fresh searches, including rejecting companies with less than 75% export earnings or software development income, companies with losses, companies with abnormal margins, or those with related party transactions exceeding 25%. The appellant challenged these filters as inappropriate and contended that economic adjustments for working capital, depreciation, and market risk should have been considered.

The Tribunal found merit in the appellant's contention regarding the inclusion of Infosys Limited as a comparable company. It relied on the appellant's own prior decision for AY 2014-15, where Infosys Limited was excluded as comparable due to its functional dissimilarity, extraordinary events impacting profitability (such as acquisitions and mergers), significant R&D and marketing expenses, and large scale of operations compared to the appellant. The Tribunal reproduced detailed findings from the prior order highlighting these differences, including the presence of intangible assets, segmental revenue differences, and extraordinary business events affecting Infosys Limited's financials.

Key Evidence and Findings: The Tribunal examined the annual reports and financial statements of Infosys Limited and other companies, noting:

• Infosys Limited's acquisition of Lodestone Holding AG and merger with Infosys Consulting India Limited, which affected its profitability.
• Infosys Limited's substantial R&D expenditure (Rs. 873 crore in FY 2014), filing of patents, and significant marketing expenses (Rs. 2,390 crore).
• The large turnover of Infosys Limited (Rs. 42,531 crore) compared to the appellant's turnover (Rs. 163 crore).
• Functional dissimilarity of other companies rejected by the appellant, such as E-Infochips Ltd. and Thirdware Solutions Ltd., which were engaged in product sales and manufacturing activities, unlike the appellant's captive IT services model.

Application of Law to Facts: Applying the principles of comparability under transfer pricing law, the Tribunal held that comparables must be functionally and risk-wise similar to the appellant. The presence of extraordinary events, diversified business models, significant intangible assets, and scale differences render companies like Infosys Limited non-comparable. The Tribunal directed the AO to exclude Infosys Limited from the final set of comparables for computing ALP.

Treatment of Competing Arguments: The Revenue argued that Infosys Limited passed all filters and that TNMM is resistant to minor differences, with percentile ranges accounting for comparability issues. The Revenue also contended that brand value should not affect the Profit Level Indicator (PLI) computation. The Tribunal rejected these arguments on the ground that the functional and operational dissimilarities materially affect the comparability and that inclusion of such companies distorts the ALP determination.

Conclusions: The Tribunal concluded that the AO/TPO/DRP erred in including Infosys Limited as a comparable company and directed its exclusion. The transfer pricing adjustment based on the inclusion of Infosys Limited was therefore not sustainable.

Penalty Proceedings Initiation

Relevant Legal Framework: Sections 270A and 274 of the Income Tax Act provide for penalty proceedings in cases of concealment or inaccurate particulars of income.

Court's Reasoning and Findings: The appellant challenged the initiation of penalty proceedings. However, during the hearing, the appellant did not press this ground. The Revenue did not object to dismissal of this ground.

Conclusion: The Tribunal dismissed the penalty-related grounds as not pressed.

Other Grounds

All other grounds raised by the appellant, except the ground relating to exclusion of Infosys Limited as a comparable, were not pressed and dismissed accordingly.

3. SIGNIFICANT HOLDINGS

The Tribunal's key legal determinations include:

• "Infosys Limited cannot be a good comparable to the appellant-company which is engaged in software development services to its AEs on cost plus basis. Infosys Limited is having huge brand value which definitely impacts the operating margins of any company. Further, Infosys Limited has been considered to be not comparable to the appellant-company in appellant-company's own case for the assessment year 2014-2015."
• "Considering the above-mentioned factors, we are of the considered view that M/s. Infosys Limited is not a comparable company with respect to the assessee company for TP Adjustments."
• "Selective inclusion or exclusion of any comparable on the basis of certain events, gives distorted figures or defeat the very purpose of provisions of sec.92C of the Income Tax Act, 1961." (Rejecting Revenue's argument for inclusion of Infosys Limited despite functional dissimilarities.)
• "Except ground no. 2 : 15 [x], all other grounds raised by the assessee in the instant appeal have been dismissed as not pressed."
• "In the result, appeal of the Assessee is partly allowed."