2025 (7) TMI 1419 - AT - Income Tax

TP Adjustment - not applying upper turnover filter - HELD THAT - In comparability analysis the learned TPO selected the comparable companies who has multi times more turnover than the assessee company. Assessee objected before the learned dispute resolution panel as per objection number five. DRP also rejected the contentions while considering each of the comparable company wherein high turnover of comparable company was demonstrated by the assessee. Thus the companies which have many folds turnover compared to the assessee were retained in comparability analysis and adjustment was made to the arm s-length price. Thus the question is that whether higher turnover companies are comparable with companies having relatively small turnover. It is undisputed that lower turnover filter of Rs 1 Crore is accepted by assessee as well as the learned transfer pricing officer to remove insignificant companies from comparability analysis. Therefore turnover filter should be applied for comparability analysis or not. If higher and lower turnover filter is applied it truncates large number of comparables by eliminating comparables which have fairly large turnover compared to the tested entity. Naturally large turnover companies have economies of scale compared to lower turnover entity. The various studies carried out by NASSCOM and Dun Bradstreet also supports it. Though such studies have compartmentalised turnover filter of Rs. 1-200 hundred crores. Naturally in transfer pricing analysis lower turnover filter and upper turnover filter cannot be fixed and how to adopt the same depends upon the facts of each case looking at the turnover of the tested entity. In fact the purpose of applying a filter is to have a manageable level of independent business concern having broadly similar level of turnover intangibles employees and other assets. Guidance note issued by ICAI also advocates the same reasoning for adopting turnover filter. Inclusion of Conciliant technologies Private Limited - This comparable could not have been taken into consideration in comparability analysis. This objection was also raised before the learned transfer pricing officer which is recorded at page number 46 of his order. There also it is categorically mentioned that the foreign exchange earnings and outgo activities relating to exports are Not Applicable in case of comparable company. Therefore we direct the learned transfer pricing officer to peruse the annual account of comparable company for the year and if there is no export turnover then it fails 75 % export turnover filter it should be excluded from the comparability analysis. Interest on outstanding receivable from associated enterprises - On analysis of these 4 invoices we find that in one case the due date of receipt is 31st of March 2020 whereas the consideration is received on 8/4/2020 and therefore even if there is an imputation of interest on outstanding receivable it does not fall in this financial year. With respect to the other two invoices the due date of receipt is 29th of April 2020 and 30th of May 2020 respectively. Both these invoices falls due for receipt in the next year. Therefore no adjustment could be made in this financial year. With respect to the fourth invoice the learned transfer pricing officer noted that the due date of receipt falls in the subsequent year so no adjustment was made. Therefore on the same logic also he should not have made any adjustment with respect to other three invoices. Accordingly allowing ground AO/ TPO is directed to delete the adjustment as interest on overdue trade receivable from associated enterprises.

Summary

ISSUES:

Whether an upper turnover filter should be applied in transfer pricing comparability analysis for software development services.Whether certain comparable companies included in the benchmarking analysis are functionally dissimilar or fail export turnover filters.Whether imputing interest on overdue trade receivables from associated enterprises constitutes a separate international transaction requiring adjustment under transfer pricing provisions.Whether the rate of interest applied on overdue receivables (Prime Lending Rate of SBI) is appropriate for transfer pricing adjustment.Whether delay in receipt of payments falling in subsequent financial years justifies imputation of interest in the relevant assessment year.

RULINGS / HOLDINGS:

The Court held that the upper turnover filter is "necessarily required to be employed for better determination of arm's-length price" in transfer pricing analysis, especially to exclude comparable companies with turnover multiple times that of the tested entity.The Court directed exclusion of nine comparable companies from the benchmarking analysis as they exceed the upper turnover filter of Rs. 200 crores, following prior coordinate bench decisions and relevant judicial precedents.The Court found that a comparable company with "100% domestic turnover" and "no export turnover" fails the 75% export turnover filter and must be excluded from comparability analysis.The Court ruled that imputing interest on overdue trade receivables from associated enterprises is not justified when the delay in receipt falls in the subsequent financial year, and thus the adjustment of Rs. 693,923/- should be deleted.The Court rejected the application of interest on overdue receivables for invoices where the due date of payment is after the end of the relevant financial year, holding that no adjustment can be made in that year.

RATIONALE:

The Court applied the transfer pricing provisions under sections 92CA and related provisions of the Income-tax Act, 1961, and relied on the OECD Transfer Pricing Guidelines (2022), ICAI Transfer Pricing Guidance Note, and relevant judicial precedents emphasizing the importance of both quantitative and qualitative criteria in selecting comparables.The Court recognized that "economies of scale" and "size criteria in terms of Sales, Assets or Number of Employees" affect comparability, and that turnover disparities materially affect profitability and competitive positions, thus necessitating turnover filters.The Court distinguished the present case from the cited Delhi High Court decision (Chris Capital) by noting that the issue there related to "super normal profits" and not the applicability of turnover filters.The Court emphasized that the arm's-length price should reflect how independent parties price transactions, implying comparability in size and scale is essential.Regarding interest on overdue receivables, the Court noted that such receivables arise in the normal course of business and do not constitute separate international transactions warranting interest imputation when payment delays extend beyond the relevant assessment year.