The Karnataka High Court has upheld the exclusion of functionally dissimilar companies and a company reporting extraordinary profits from transfer pricing comparables, dismissing the Income Tax Department’s appeal concerning Assessment Year 2008-09.
The Bench of Chief Justice Vibhu Bakhru and Justice K.S. Hemalekha held that including a company whose abnormal results arose from extraordinary circumstances would distort the average profit level indicator and undermine the determination of the arm’s length price.
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The assessee filed its return for AY 2008-09 on September 13, 2008, declaring total income of ₹39,42,40,650. The return was initially processed under Section 143(1) of the Income Tax Act, 1961, and subsequently selected for scrutiny.
Since the assessee had undertaken international transactions with associated enterprises, the Assessing Officer referred the matter to the Transfer Pricing Officer under Section 92CA.
The assessee adopted the Transactional Net Margin Method to establish that its transactions were at arm’s length. However, the TPO rejected its analysis, questioning the qualitative filters used to eliminate companies, the use of current-year data and the application of the related-party transaction filter.
The TPO also noted that the assessee had selected companies predominantly providing onsite services, whereas it rendered services through centres located in India.
After selecting separate sets of 20 comparables for technical services and IT-enabled services, the TPO proposed adjustments of ₹16,29,24,390 and ₹1,95,05,997, respectively. The total adjustment amounted to ₹18,24,30,387.
Following rejection of the assessee’s objections by the Dispute Resolution Panel, the Assessing Officer passed the final assessment order on July 13, 2012. The assessee appealed to the Tribunal, challenging the inclusion of certain companies as comparables. The Tribunal accepted its objections.
The High Court had initially dismissed the Revenue’s appeal on July 13, 2018, relying, among other authorities, on its decision in Softbrands India Pvt. Ltd.
The Revenue approached the Supreme Court, where the matter formed part of the batch decided in SAP Labs India (P) Ltd. v. Income Tax Officer, reported in (2023) 454 ITR 121 (SC).
As recorded in the present judgment, the Supreme Court clarified that whether an arm’s length price had been determined in accordance with the Act and Rules could give rise to questions of law. Transfer pricing appeals could therefore not all be rejected on the ground that they involved no substantial question of law.
The present appeal was remanded for examination of the transfer pricing questions in light of those observations.
The Revenue disputed the exclusion of Avani Cincom Technologies Ltd., Celestial Labs Ltd., Infosys Technologies Ltd., KALS Information Systems Ltd., Tata Elxsi Ltd. and Wipro Ltd.
It also questioned the exclusion of Infosys and Wipro on grounds involving premium branding, arguing that branding was only one of the factors affecting profitability.
The High Court noted that it had already examined the exclusion of these entities in the assessee’s case for AY 2007-08, in ITA No. 338/2013, and had found no fault with the Tribunal’s decision.
Accordingly, the Bench held that these questions were covered in favour of the assessee by that decision.
Outsourcing Model Relevant To Comparability
In the IT-enabled services segment, the dispute concerned Coral Hubs Ltd., Eclerx Services Ltd. and Mold-Tek Technologies Ltd.
The Tribunal had excluded Coral Hubs, formerly Vishal Information Technologies Ltd., because it subcontracted most of its IT-enabled services work to third-party vendors. It also referred to earlier decisions discussing the company’s print-on-demand business and substantial outsourcing.
The High Court observed that these factual findings were not challenged. Revenue’s counsel did not dispute that Coral Hubs followed an outsourcing model and did not perform all activities in-house.
The Bench also discussed the Delhi High Court’s decision in Rampgreen Solutions (P) Ltd. v. Commissioner of Income Tax, which distinguished higher-end knowledge process outsourcing services from routine business process outsourcing services for determining comparability through profit level indicators.
The Court noted that Eclerx had been excluded for similar reasons. Whether these companies should be excluded depended on factual findings concerning their functional profiles.
Mold-Tek Technologies had reported a 96.66% margin in the relevant assessment year. The Tribunal found this abnormally high and attributable to extraordinary circumstances.
It referred to the Special Bench decision in Maersk Global Centres (India) Pvt. Ltd., which recorded that another company had merged with Mold-Tek with effect from October 1, 2006, affecting its consolidated results.
The High Court held that including Mold-Tek as a comparable would skew the mean profit level indicator and undermine the process of determining the arm’s length price.
The Bench explained that transfer pricing analysis seeks to ensure that taxable profits are not shifted through international transactions with associated enterprises. For that purpose, comparables reporting abnormal results because of extraordinary circumstances must be excluded.
The ruling connects the exclusion to the extraordinary circumstances affecting the company’s results. It does not prescribe automatic exclusion of every company earning a high margin.
The Revenue also raised a question based on the premise that excluding a company selected through particular filters would change the entire comparable-company matrix and require a fresh search.
However, its counsel accepted that this question did not arise on the facts.
The Tribunal had not directed the application of a new filter. It had merely accepted that certain companies selected through the existing filters required exclusion for the reasons recorded in its order.
The High Court consequently found no substantial question of law on this issue.
A separate question concerned whether telecommunication charges and foreign-currency expenditure excluded from export turnover should also be excluded from total turnover when computing the Section 10A deduction.
Revenue’s counsel acknowledged that this issue had already been concluded against the Department by the High Court’s July 13, 2018 judgment.
Since the Supreme Court’s remand was confined to transfer pricing, the issue was not reopened.
The High Court concluded that the Tribunal’s exclusion of the disputed comparables was not contrary to the Act or Rules. Finding no substantial question of law arising from those exclusions, it dismissed the Revenue’s appeal.
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