Facts of the Case

  • The respondent-assessee was engaged in software development services for its Associated Enterprise (AE) in the USA.
  • The assessee applied the Transactional Net Margin Method (TNMM) and declared its transactions to be at Arm’s Length Price (ALP).
  • The Transfer Pricing Officer (TPO) rejected the study and introduced four comparables:
    • Infosys Ltd.
    • Wipro Technology Services Ltd.
    • Persistent Systems Ltd.
    • Thirdware Solutions Ltd.
  • This resulted in an upward adjustment in income.
  • ITAT later excluded these comparables based on functional dissimilarity.

Issues Involved

  1. Whether under TNMM, broad functional similarity is sufficient for selecting comparables?
  2. Whether ITAT was justified in excluding the four comparables for determining ALP?
  3. Whether factors like brand value, scale, risk profile, and absence of segmental data affect comparability?

Petitioner’s Arguments (Revenue)

  • TNMM allows greater flexibility, and strict functional similarity is not required.
  • Differences in turnover, brand, or size should not automatically exclude comparables.
  • Once comparables pass filters, they should not be removed later.
  • Functional differences have minimal impact at the net margin level.
  • Relied on OECD Guidelines and case laws like Rampgreen Solutions and Chryscapital.

Respondent’s Arguments (Assessee)

  • Functional similarity under FAR analysis (Functions, Assets, Risks) is mandatory.
  • Large companies with brand value and diversified functions cannot be compared with captive service providers.
  • Lack of segmental data makes comparison unreliable.
  • Relied on precedents:
    • Rampgreen Solutions Pvt. Ltd.
    • Avaya India Pvt. Ltd.
    • Agnity India Technologies Pvt. Ltd.

Court Findings / Order

  • The Delhi High Court upheld ITAT’s decision.
  • Key Findings:
    • Functional similarity is mandatory even under TNMM.
    • Comparability must consider:
      • Functions performed
      • Assets employed
      • Risks assumed (FAR analysis)
    • Large companies with:
      • High brand value
      • Diversified operations
      • Significant intangibles
        cannot be compared with captive service providers.
  • The Court confirmed exclusion of:
    • Infosys Ltd. (giant company with brand and diversified functions)
    • Wipro Technology Services Ltd. (related party transactions issue)
    • Persistent Systems Ltd. (no segmental data)
    • Thirdware Solutions Ltd. (functional dissimilarity & mixed revenue)

Important Clarifications by Court

  • TNMM does not dilute comparability standards.
  • Broad classification (e.g., all software companies) is insufficient.
  • Functional similarity must exist in all material aspects affecting profitability.
  • High turnover alone is not a ground for exclusion—but combined factors (brand, risk, scale) are relevant.
  • Courts emphasized consistency with earlier rulings like:
    • Rampgreen Solutions Pvt. Ltd.
    • Chryscapital Investment Advisors (India) Pvt. Ltd.

Sections Involved

  • Section 260A – Appeal to High Court
  • Section 92C – Arm’s Length Price
  • Section 92CA – Reference to TPO
  • Section 10B – Determination of ALP (Rules)
  • Section 143(3), 144C – Assessment Proceedings

Link to download the order -https://delhihighcourt.nic.in/app/case_number_pdf/2020:DHC:1934-DB/SVN18052020ITA2012018_201608.pdf

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