The Karnataka High Court has held that the tolerance range of ±5% provided under Section 92C of the Income Tax Act, 1961, cannot be treated as a standard deduction while determining the arm’s length price of an international transaction.
A Division Bench of Justice S.G. Pandit and Justice K.V. Aravind ruled that the ±5% range merely prescribes the permissible variation within which no further transfer-pricing adjustment is required. Once the difference exceeds the statutory range, the taxpayer cannot claim an automatic deduction of 5% from the arithmetic mean.
The High Court held that Chapter X of the Income Tax Act constitutes a self-contained code governing transfer pricing. It provides a comprehensive statutory framework for determining the arm’s length price, maintaining supporting documentation and assessing international transactions between associated enterprises.
Buy Now: Income tax E-Compilation – August 2026
The initial responsibility to determine the arm’s length price and maintain the prescribed documentation rests with the taxpayer. However, a Transfer Pricing Officer can interfere with the taxpayer’s determination only after satisfying the conditions prescribed under Section 92C(3).
Where the taxpayer’s transfer-pricing study is rejected and the TPO undertakes a fresh benchmarking exercise, the officer must justify the inclusion or exclusion of comparable companies by applying the statutory requirements.
The Court said that a TPO cannot reject the taxpayer’s comparables merely to replace them with a standard set of comparables routinely used by the Income Tax Department. The exercise must be based on the particular international transaction and strictly conform to Rule 10B of the Income Tax Rules, 1962.
±5% Range Cannot Be Added to Taxpayer’s Margin
The principal dispute in the SAP India appeals concerned the Tribunal’s interpretation of the proviso to Section 92C(2).
The Tribunal had allowed the benefit of 5% by treating it as a standard deduction before examining whether the price charged by the taxpayer fell within the permissible range from the arithmetic mean of comparable prices.
Rejecting this approach, the High Court held that the tolerance range does not confer an independent deduction. It only protects the price adopted by the taxpayer when the difference between that price and the arm’s length price remains within the statutorily prescribed percentage.
Accordingly, a transfer-pricing adjustment becomes necessary when the variation exceeds the permissible limit.
The Court further held that Section 92C(2A), inserted by the Finance Act, 2012 with retrospective effect from April 1, 2002, applies from Assessment Year 2002-03 onwards. The amendment withdrew the benefit that had been claimed under the pre-amended proviso.
Since the dispute concerning SAP India related to Assessment Year 2003-04, the retrospective provision was held to apply squarely to the case.
The questions relating to the ±5% benefit were therefore answered in favour of the Income Tax Department and against the taxpayer. The Tribunal’s findings were set aside, and the matter was remitted to the TPO for fresh determination.
The Revenue had also challenged the Tribunal’s exclusion of Hinduja TMT Limited and Aftek Infosys Limited on the ground that the companies had earned supernormal profits.
The High Court noted that the Tribunal’s decision to exclude these companies was connected with the benefit claimed under the earlier proviso to Section 92C(2). Since that benefit stood retrospectively withdrawn, the correctness of excluding the two companies required reconsideration.
The Court consequently set aside the Tribunal’s order to the extent it excluded Hinduja TMT and Aftek Infosys and remitted the question to the Tribunal for fresh consideration in accordance with law.
At the same time, the Court recognised the broader principle that companies earning abnormal profits or suffering abnormal losses may be unsuitable for benchmarking where those circumstances impair the reliability of the comparison.
In the appeal filed by SAP Labs India Private Limited, the Court examined whether the Tribunal was justified in excluding comparable companies whose margins were below 6%.
SAP Labs had entered into a contract with its German associated enterprise under which it operated on a cost-plus-6% basis in a risk-mitigated environment. Considering this contractual structure, the Tribunal had excluded companies earning margins below 6%.
The High Court found no error in that approach. It observed that arm’s length analysis requires comparison with companies that are similar in terms of functions performed, assets employed, risks assumed and contractual arrangements.
Since SAP Labs’ contract itself provided for a cost-plus-6% remuneration, the Tribunal’s decision was based on the peculiar facts of the case and settled transfer-pricing principles. The finding did not violate the Income Tax Act or the applicable Rules and therefore did not give rise to a substantial question of law.
SAP Labs had also challenged the inclusion of Satyam Computers Limited as a comparable, arguing that its audited financial statements were unreliable because of alleged falsification.
The High Court declined to direct its exclusion.
The Court noted that the Tribunal had considered ten comparable companies with profit margins ranging from 6.09% to 40.96%. Satyam’s margin was 30.86%, while two other companies had margins of 40.96% and 35.88%.
According to the Court, no prima facie material establishing falsification of the relevant financial statements had been placed on record, apart from a reference to proceedings initiated against the company’s managing director.
The Court also noted that Satyam was only one among ten comparables and that SAP Labs had not challenged the inclusion of other companies earning even higher or similar profit margins. It therefore found no ground to exclude Satyam merely on the contention advanced by the taxpayer.
Laying down an important principle concerning company size, the High Court upheld the Tribunal’s adoption of an upper turnover filter of Rs 200 crore.
The Court held that turnover is not an irrelevant consideration in transfer-pricing analysis. Factors such as brand value, economies of scale, bargaining power and ownership of valuable intangibles can materially influence profitability and comparability.
The Rs 200 crore turnover ceiling adopted by the Tribunal was consequently found to be rational and legally sustainable.
In one of the connected appeals, the Tribunal had excluded six companies whose turnover was about 23 times that of the tested taxpayer. The High Court upheld the exclusion, observing that the Revenue had neither pleaded nor demonstrated that the Tribunal’s factual findings were perverse.
The Court also approved 15% as the ordinarily applicable related-party transaction, or RPT, filter for selecting comparable companies.
A threshold of 20% or 25% may be adopted only when sufficient comparable companies satisfying the lower 15% threshold are unavailable. The authority must also record a specific finding explaining the need to apply the higher limit.
In the absence of such a finding, the normal benchmark of 15% must be followed.
The Court observed that selection of an RPT filter is largely a factual exercise. Unless the Tribunal’s decision is shown to be perverse or inconsistent with the statutory provisions, it would ordinarily not warrant interference in an appeal under Section 260A.
On the treatment of foreign-exchange gains and losses, the High Court ruled that such items cannot automatically be classified as operating in nature.
A foreign-exchange gain or loss can be included in operating revenue or operating cost only where it has a direct nexus with the international transaction under examination. The underlying contracts must establish that connection.
Whether such a nexus exists must be determined on the facts of each case. The Court therefore remitted the forex issues arising in the connected appeals to the respective TPOs for verification.
The Court held that the selection or exclusion of comparable companies is essentially factual and data-driven. A High Court may interfere where the exercise violates Section 92C or Rule 10B, or where the Tribunal’s conclusions are perverse.
However, a mere disagreement over the chosen comparables does not automatically give rise to a substantial question of law.
The Court also clarified that there is no absolute legal bar against adding or removing comparable companies at the appellate stage. Subsequently available information may be considered if it is reliable and the proposed comparable satisfies the requirements of the Income Tax Act and Rules.
Similarly, working-capital adjustment was characterised as a comparability adjustment rather than a selection filter. Its availability depends on the facts of the individual case, and the Tribunal’s findings would ordinarily remain findings of fact unless they are contrary to law or demonstrably perverse.
The batch of cases came before the High Court following a remand by the Supreme Court in SAP Labs India Private Limited.
The Supreme Court had rejected the proposition that every determination of arm’s length price by the ITAT becomes final and is immune from scrutiny under Section 260A. It directed High Courts to examine whether the statutory transfer-pricing provisions had been followed and whether the Tribunal’s findings were perverse.
Applying those directions, the Karnataka High Court examined the individual issues in the connected appeals, upheld several factual findings of the Tribunal and remitted the questions requiring renewed examination to the Tribunal or the TPO.
Membership Required to Access Case Details & Order Copy
To view the complete Case Details and Download Order Copy, you must have an active membership. Please subscribe to continue.
