Similarity Of Functional Filters & Business Model Is Necessary For Including/ Excluding Comparable To Determine Arm's Length Price: Delhi HC

Further, for purposes of benchmarking, there must be similarity of functional filters, product homogeneity and business model, in order to arrive at suitable comparable for determination of arm's length price, added the Court.

Hence, the High Court remanded the matter back to the ITAT for deciding afresh the assessee's objections regarding to selection of Ishir Infotech, Tata Elxsi, Sasken Communication Technologies, and Akshay Software Technologies, as comparable.

The Division Bench comprising Justice Vibhu Bakhru and Justice Swarana Kanta Sharma observed that the assessee's objection to the exclusion of one comparable (Akshay Software Technology) was not on the ground of revenue filter but on account of onsite revenue filter as applied by the TPO.

However, there was an apparent error inasmuch as the ITAT's decision to exclude such comparable was passed without considering assessee's basis for challenging the exclusion, which rendered the decision of the ITAT unsustainable, added the Bench.

Facts of the case:

The assessees had adopted the Transactional Net Margin Method with the ratio of operating profit to costs as the Profit Level Indicator for determining the arm's length price (ALP) in respect of its transactions with their associate enterprises (AEs). When the matter was referred to the TPO, he determined the ALP based on the filters and after selecting certain uncontrolled comparable entities. Resultantly, the TPO proposed an upward adjustment of Rs.24.34 crores u/s 92CA(3).

Observations of the High Court

The Bench referred to the submission that ITAT's inclusion of Avani Cincom Technologies Ltd was ex facie erroneous as ITAT proceeded on the assumption that Avani is not a product company but is engaged in software development for its clients/customers.

The Bench further noted that TPO had concluded that 97% of the company's income was from software development and no part of the income was from product export.

At the same time, the Bench observed that such assumption is not supported by information available on the company's website, as the company, in its response to the notice u/s. 133(6) stated that it was a 'pure software development service provider'.

However, the Bench clarified that the statement by company does not imply that it does not sell software products developed by it.

Also, the Bench noted that TPO/ DRP proceeded without ascertaining whether the products as mentioned on its website were, in fact, sold /licensed during FY 2006-07.

Since the company derived revenue from both software development services and sale of software products, the Bench observed that both TPO and ITAT erred in not excluding Avani as a comparable entity.

As regards Ishir Infotech Ltd, the Bench considered the Assessee's submission that the business model followed by Ishir was largely outsourcing its activities and sub-contracting services.

Further, as regards exclusion of Akshay Software Technologies, the Bench highlighted that even though assessee's challenge to the same before ITAT is sketchy as no specific ground was taken or articulated, nonetheless, there is an apparent error inasmuch as assessee's basis for challenging the exclusion was not considered by the ITAT.

The Bench also noted that assessee's challenge to inclusion of Tata Elxsi Limited and Sasken Communication Technologies Limited, as also set out in the miscellaneous applications filed by assessee, was not adjudicated by ITAT.

Hence, the High Court set aside the ITAT's order to the limited extent of rejecting assessee's challenge to inclusion of Avani Cincom Technologies Limited, Ishir Infotech Limited, Tata Elxsi Limited and Sasken Communication Technologies and exclusion of Akshay Software Technologies Limited as comparable for the purpose of determining ALP.

Counsel for Appellant/ Assessee: Advocates Nageshwar Rao and Parth

Counsel for Respondent/ Revenue: Advocates Indruj Singh Rai, Sanjeev Menon, Rahul Singh, and Anmol Jagga.

Case Title: ALCATEL LUCENT INDIA LIMITED vs DCIT

Case Number: ITA 220/2022

Click Here To Read/Download The Judgment