The Delhi High Court remanded the matter to Income Tax Appellate Tribunal (ITAT) in an appeal challenging uncontrolled entities as comparables for determining ALP (Arms’s Length Pricing).

The bench of Justice Vibhu Bakhru and Justice Swarana Kanta Sharma has observed that the matters are remanded back to the Tribunal for deciding afresh the appellant’s objections in regard to inclusion and exclusion of Ishir Infotech Ltd, Tata Elxsi Limited, Sasken Communication Technologies Limited and Akshay Software Technologies Limited for determining the Arm’s Length Pricing (ALP) adjustment, if any. It is clarified that all contentions of the parties on the merit whether the said companies are required to be included or excluded, are reserved.

Background

The controversy involved in these appeals relates to the enhancement of total income chargeable to tax on the basis of orders passed by the Transfer Pricing Officer (TPO).

The assessees/appellant adopted the Transactional Net Margin Method (TNMM) with the ratio of operating profit (OP) to costs as the Profit Level Indicator (PLI) for determining the arm’s length price (ALP) in respect of transactions of the assessees with their associate enterprises (AEs).

The TPO rejected the Transfer Pricing Studies furnished by the assessees and determined the ALP on the basis of filters selected certain uncontrolled comparable entities for determining the PLI on arm’s length basis.

In the case of ALTIPL, the TPO determined its operating profit margin to be 25.44%, which was significantly higher than ADIPL’s operating profit margin of 10.57%.

Accordingly, the TPO passed an order under Section 92CA(3) proposing an upward adjustment of Rs. 27,91,55,906 in respect of the ADIPL’s software development segment.

The AO passed a draft assessment order assessing the appellant’s total income as Rs. 29,46,35,755.

The appellant objected to the draft assessment orders before the Dispute Resolution Panel (DRP). The DRP upheld the adjustment proposed by the TPO and accordingly, ALTIPL’s income was enhanced. The AO passed a final assessment order.

The appellant’s challenge is confined to including certain uncontrolled entities as comparables for determining the ALP and excluding certain uncontrolled entities as comparables as suggested by the appellant.

Issues Raised

Whether the Tribunal misdirected itself on facts and in law, in not excluding the comparables Avani Cincom Technologies Ltd. and Ishir Infotech Ltd. in determining the Arm’s Length Price concerning the international transactions undertaken by the appellant/assessee with an Associated Enterprise?
Whether the Tribunal misdirected itself both on facts and in law in not including the comparable Akshay Software Technologies Limited in determining the Arm’s Length Price concerning the international transaction undertaken by the appellant/assessee with an Associated Enterprise?
Whether the Tribunal misdirected itself on facts and in law in failing to adjudicate the contentions of the appellant/assessee with regard to the exclusion of the following comparable companies: Tata Elxsi Limited and Sasken Communication Technologies Limited?”

Avani Cincom Technologies Limited

Avani’s website clearly indicated that one of its products DXchange is available in three versions. The software is to be hosted on the customers’ site and its revenue model is the annual licence fee model. Avani’s Content Management System is also available in four separate versions.

The TPO had disregarded the information available on the website of Avani on the assumption that Avani’s response was to the contrary. The TPO had reasoned that the information available on the website may not be relevant to the financial year 2006-07 and may contain forward looking statements but Avani’s response to the notice under Section 133(6) of the Act was unambiguous.

No specific explanation was sought from Avani regarding the products mentioned on its website. The TPO proceeded only on the basis that the same may not be relevant without ascertaining whether the products as mentioned by Avani on its website were, in fact, sold/licensed during the financial year 2006-07.

Court’s Ruling

The court noted that the annual report of Avani shows that the company derives its revenue from both software development services and sale of software products. In view of the above, the TPO and the Tribunal, have erred in not excluding the Avani as a comparable entity for the purpose of determining the ALP.

Ishir Infotech Ltd.

The assessees objected to the inclusion of Ishir Infotech Ltd. (hereafter Ishir) as a comparable entity on two grounds. First, that it had failed the employee cost filter. The TPO issued a notice under Section 133(6) of the Act to the said company and based on the information received in response thereto, had determined that it not only qualified the 25% employee cost filter but other filters as well.

The question whether the business model is different and therefore Ishir would not be an appropriate comparable uncontrolled entity has not been considered by the Tribunal. As noted above, the decision in the case of Infogain India (P) Ltd. v. Deputy Commissioner of Income Tax, Circle 11(1), New Delhi (supra) was cited before the Tribunal but the same has not been alluded to by the Tribunal, as well.

Court’s Ruling

The order insofar as it rejects the appellant’s challenge to inclusion of Ishir as a comparable entity, is erroneous.

M/s Akshay Software Technologies

It is the asseessee’s case that Akshay is compliant with all the filters chosen by the TPO and the decision to exclude the same from consideration was unjustified. The TPO found that Akshay has more than 75% of its revenue from onsite services.

The TPO issued a notice under Section 133(6) of the Act and called upon Akshay to submit its onsite revenue details. Apparently, the information submitted by Akshay indicated that it generated 100% of its export revenue from onsite operations. The appellant objected to the onsite revenue criteria for selection or rejection of companies as comparables.

It contended that any taxpayer engaged in software development services is bound to have offshore and onsite revenues. The composition of such revenues would vary from year to year.

The appellant submitted that onshore and offshore revenues may yield different profit margins but the profit margin of an enterprise was required to be considered as a whole on the basis of functional similarity.

It is the Revenue’s case that the assessee had a consistent mark up on costs and therefore its profitability did not undergo any change on account of onsite and offshore mix of operations. In addition, the appellant also submitted that the mix of offshore and onsite revenues was available in the public domain.

Court’s View

The court held that there is an apparent error inasmuch as the appellant’s basis for challenging the exclusion of the Akshay has not been considered by the Tribunal. Thus, the Tribunal’s decision to exclude Akshay as a comparable entity, is unsustainable. In view of the above, it is apposite to remand the appeal to the Tribunal to consider the asseessee’s challenge to the exclusion of Akshay as a comparable.

Inclusion of Tata Elxsi Limited (hereafter Tata) and Sasken Communication Technologies

The appellant had also objected to inclusion of Tata Elxsi Limited (hereafter Tata) and Sasken Communication Technologies Limited (hereafter Sasken) as comparable entities.

According to appellant, its challenge to the inclusion of the companies as comparable entities has not been adjudicated by the Tribunal.

The appellant had also filed miscellaneous applications before the Tribunal praying that its challenge to inclusion of the said companies as comparable entities be adjudicated. It is relevant to refer to the appellant’s challenge to inclusion of the said companies as set out in the miscellaneous applications filed by the appellant before the Tribunal.

Court’s View

The court held that the appellant had withdrawn its miscellaneous applications in view of the statement made before this Court on 01.02.2023. The learned counsel for the assessee contended that the said statement was made as the Revenue had objected to the appellant pursuing its remedies before this Court as well as by filing miscellaneous applications before the Tribunal.

Conclusion – Comparables For Determining ALP

The court set aside the order to the limited extent of rejecting the appellant’s challenge to inclusion of Avani Cincom Technologies Limited, Ishir Infotech Limited, Tata Elxsi Limited and Sasken Communication Technologies as comparables for the purpose of determining ALP and excluding Akshay Software Technologies Limited as comparable for the purpose of determining the ALP.