2023 (4) TMI 1417 - AT - Income Tax

TP Adjustment - benchmarking analysis of comparable companies selected by the assessee - HELD THAT - Parexel International (India) Services Pvt. Ltd. is functionally comparable as it is engaged in IT and ITES services and the assessee could not controvert the factual findings of the TPO which are based on annual report. Admittedly there is no dispute that the assessee is also engaged in Information Technology Enabled Services we find no infirmity in the findings of DRP in confirming the view of TPO in retaining Parexel International (India) Pvt. Ltd. as comparable consequently which resulted in final assessment order holding the same. Exclusion of 24/7 Customer Pvt. Ltd. as comparable - 24/7 Customer Pvt. Ltd. is into the business of IT enables services and is very difficult to find out the exact services from the said context as rightly pointed by the ld. DR. Admittedly there is no dispute with regard to the business of assessee company engaged into IT enables services which is also that of 24/7 Customer Pvt. Ltd. as emanating from the annual report referred above therefore we find no infirmity in the findings of DRP in confirming the view of TPO in retaining 24/7 Customer Pvt. Ltd. as comparable consequently which resulted in final assessment order holding the same. Exlservice.Com (I) Pvt. Ltd. - Though it is mentioned BPO and KPO in its business process but revenue earned at 100% from BPO. Admittedly no further details were given in the financials therefore we find no infirmity in the findings of DRP in confirming the view of TPO in retaining Exlservice.Com (I) Pvt. Ltd. as comparable consequently which resulted in final assessment order holding the same. Datamatics Business Solutions Ltd. - Application of filter regarding the failure of foreign currency/sales as applied by the TPO is factually correct as it was not material for the current year as it being examined for quantitative filter. ON perusal of annual report of Datamatics Business Solutions Ltd. at page 279 which clearly shows that there was no foreign currency transaction for the year ended on 31-03-2015 and also on 31-03-2016 but however there is a gain in the year under consideration as on 31-03-2017. Admittedly this issue was not discussed by the TPO and both the parties were agreed in remanding the said issue to the file of TPO for its fresh consideration regarding the examination of filter category of foreign currency/sales. Thus we deem it proper to remand the issue of comparability under foreign currency/sales filter to the file of TPO. The assessee is liberty to file evidences if any in support of its claim. Tech Mahindra Business Services Ltd. is engaged in the business of providing ITES to its clients abroad which is supported by the Revenue from operations at page 1462 and also the principal business which contributing 100% to the total turnover of the said company is IT enabled services at page 1443 of the paper book therefore we find no infirmity in the findings of DRP in confirming the view of TPO in retaining Tech Mahindra Business Services Ltd. as comparable consequently which resulted in final assessment order holding the same. Manipal Digital Systems Private Limited.- As per Indian Council for Advertising the online advertising has to be published on true and honest disclosure basis and therefore when proper documentation of activities are not physically available in such scenario referring the website for information is correct option and the information therein cannot be doubted. These are all multi-national companies and certain amount of honesty has to be attributed to them since all are functioning as per relevant rules and laws. We direct the AO/TPO to exclude this company i.e. Manipal Digital Systems Private Limited from the final set of comparables with that of the assessee company. CES Limited. - Segregation of ITes services has to be categorically conducted before classifying as functionally comparable with another. In this case Revenue Authorities have only looked into the revenue earning from ITes segment and included this company as comparable. The facts remains both these companies are functionally different. We therefore direct the AO/TPO to exclude CES Limited from the final set of comparables with that of the assessee company. MPS Ltd. is functionally different from that of the assessee company in more-so that high end activities of MPS Ltd is akin to IT services and not ITes. Thus we direct the AO/TPO to exclude MPS Limited from final list of comparable companies. Domex E-Data Private Limited company is functionally not comparable with that of the assessee company. We therefore direct the AO/TPO to exclude this company. R Systems International Limited (BPO) excluded only on the ground that the data is available of different accounting year we direct the AO to extrapolate the available data for the comparative period.

Summary

The core legal questions considered in this appeal pertain to the determination of arm's length price (ALP) in international transactions under transfer pricing regulations, specifically focusing on the selection and rejection of comparable companies for benchmarking analysis. The key issues include: (1) the validity of the reference to the Transfer Pricing Officer (TPO); (2) the appropriateness of the comparable companies selected by the TPO and the Dispute Resolution Panel (DRP); (3) the functional comparability of the selected companies with the assessee; (4) the application of quantitative filters such as turnover and foreign exchange earnings in selecting comparables; (5) the methodology of computing operating margins of comparables; and (6) the inclusion or exclusion of specific companies as comparables based on their business activities and segmental details.

The first issue regarding the validity of the reference to the TPO was raised by the assessee through additional grounds of appeal challenging the jurisdiction or validity of the TPO's involvement. The Tribunal, after hearing both parties and considering the record, rejected these additional grounds, holding that they did not require factual examination and dismissing them outright. This establishes that procedural validity of the TPO's reference was not found to be flawed.

Regarding the benchmarking analysis, the Tribunal examined the selection of comparable companies by the TPO and the DRP. The assessee challenged several companies included as comparables on the basis that they were functionally dissimilar, engaged in different business activities, or failed to meet certain filter criteria. The Tribunal analyzed each contested comparable in detail, applying relevant legal principles and precedents.

The legal framework governing transfer pricing comparability analysis requires that the tested party and comparables be functionally similar, considering factors such as the nature of services, risks assumed, assets employed, and business environment. The Indian Income Tax Rules, specifically Rule 10B(2)(a), mandate comparability to be judged with reference to service/product characteristics. Precedents emphasize that merely falling under a broad category such as Information Technology Enabled Services (ITES) does not suffice for comparability; the specific nature and content of services must be examined.

In assessing the comparability of companies like Parexel International (India) Pvt. Ltd. and 24/7 Customer Pvt. Ltd., the Tribunal noted that both companies were engaged in ITES segments similar to the assessee, supported by their annual reports and segmental disclosures. The TPO and DRP's findings that these companies provided IT and ITES services were upheld, and the Tribunal found no infirmity in retaining them as comparables. The Tribunal acknowledged the difficulty in precisely differentiating services within the ITES sector but accepted the broad functional alignment based on documentary evidence.

Conversely, the Tribunal excluded several companies from the final list of comparables after detailed scrutiny and reference to prior Tribunal decisions. For Manipal Digital Systems Pvt. Ltd., CES Limited, MPS Ltd., and Domex E-Data Pvt. Ltd., the Tribunal relied on previous rulings where these companies were held functionally dissimilar due to their engagement in higher-end Knowledge Process Outsourcing (KPO) or digital publishing activities, which differ materially from the assessee's business of lower-end Business Process Outsourcing (BPO) or back-office ITES services. The Tribunal emphasized the Delhi High Court's ruling that ITES is a broad spectrum and that comparability requires analysis beyond the broad sector classification to the specific nature of services rendered.

The Tribunal also highlighted the necessity for the TPO and DRP to provide explicit reasons for including companies as comparables, particularly when functional differences exist. It was noted that reliance solely on revenue percentages from ITES segments without detailed functional analysis is insufficient. The Tribunal underscored the principle that the onus lies on the Revenue authorities to justify the selection of comparables and that the assessee has the right to challenge functional dissimilarities.

Regarding the application of quantitative filters, the Tribunal remanded the issue related to Datamatics Business Solutions Ltd. for fresh consideration, particularly concerning the foreign currency earnings to sales filter. The Tribunal granted liberty to the assessee to submit evidence, indicating the importance of precise and consistent application of filters in the comparability analysis.

The Tribunal also addressed the exclusion of R Systems International Limited, which the TPO had rejected due to data being from a different financial year. Relying on precedent, the Tribunal directed the AO to include this company by extrapolating the available data to the relevant period, reinforcing the principle that data from different accounting years may be adjusted rather than outright excluded if otherwise comparable.

In applying the law to facts, the Tribunal meticulously examined the annual reports, segmental disclosures, websites, and auditor's notes of the companies in question. It balanced the assessee's contentions regarding functional dissimilarities with the Revenue's reliance on broad sector classification and documentary evidence. The Tribunal gave weight to judicial precedents that caution against broad-brush comparability assumptions within the ITES sector and insisted on detailed functional comparability analysis to ensure accurate ALP determination.

Competing arguments centered on whether broad ITES classification suffices for comparability or whether detailed functional distinctions between BPO and KPO services, or other specialized activities, must be recognized. The Tribunal sided with the latter view, emphasizing the need for granular analysis and rejecting the notion that all ITES providers are functionally comparable. It also rejected the Revenue's reliance on website information when not corroborated by segmental financial details, recognizing the importance of reliable and consistent data sources.

The Tribunal's conclusions on each issue were as follows: the additional grounds challenging the TPO's reference were dismissed; general grounds were not adjudicated; ground No. 8 was dismissed as not pressed; the inclusion of certain comparables such as Parexel International and 24/7 Customer Pvt. Ltd. was upheld; the exclusion of Manipal Digital Systems Pvt. Ltd., CES Limited, MPS Ltd., and Domex E-Data Pvt. Ltd. was directed based on functional dissimilarity; the issue regarding Datamatics Business Solutions Ltd. was remanded for reconsideration; and the inclusion of R Systems International Limited was directed with data extrapolation.

Significant holdings include the Tribunal's verbatim reliance on the Delhi High Court's ruling that "such service could include rendering highly technical services by qualified technical personnel involving advanced skills and knowledge... while on the other end of the spectrum ITes would also include voice based call centers that render routine customer support... Treating the said entities to be comparables only for the reason that they use Information Technology for the delivery of their services, would, in our opinion, be erroneous." This principle was pivotal in excluding certain companies from the comparables list.

The Tribunal also stated: "The comparability must be judged on factors such as product/service characteristics, functions undertaken, assets used, risks assumed. This is essential to ensure the efficacy of the exercise... The object is to ascertain the ALP of the service rendered and not of a service (higher in value chain) that may possibly be rendered subsequently."

In sum, the Tribunal established that transfer pricing comparability requires detailed functional analysis beyond broad sector classification, that the Revenue must justify inclusion of comparables with specific reasons, and that the assessee's challenges on functional dissimilarity must be duly considered. The final determination partially allowed the appeal, directing exclusion of certain comparables and remanding specific issues for reconsideration, thereby ensuring a more precise and equitable benchmarking process for ALP determination in international transactions.