Delhi High Court Affirms ITAT Ruling on Comparables for Arm's Length Price Assessment

Delhi High Court Affirms ITAT Ruling on Comparables for Arm's Length Price Assessment

The Delhi High Court affirmed the Income Tax Appellate Tribunal's (ITAT) ruling regarding the selection of comparables for determining the arm's length price of an international transaction.

The Bench of Justices Rajiv Shakdher and Girish Kathpalia remarked that the Tribunal not only adhered to the aforementioned orders to ensure consistency but also meticulously scrutinized the entirety of the available evidence to determine the comparability of each of the comparables to the respondent or assessee's case for AY 2007-08.

The company under consideration, the assessee, provides investment advisory services to its overseas Associated Enterprise (AE), generating revenue of ₹48,49,75,777 in the financial year corresponding to the Assessment Year (AY) 2011-12.

To establish an arm's length price for its transactions with the AE, the assessee employed the Transactional Net Margin Method (TNMM) as the most suitable method. To this end, they selected four companies as comparables. Applying the operating profit to the operating cost profit level indicator, the average margin for the comparables was calculated to be 6.28 per cent.

Despite accepting the TNMM as the most appropriate method, utilising operating profit to operating cost as the profit level indicator, the Transfer Pricing Officer (TPO) rejected the benchmarking exercise due to the respondent/assessee's significantly higher margin of 25.84 per cent.

The TPO concluded that the respondent/assessee's failure to apply appropriate qualitative and quantitative filters resulted in the exclusion of functionally similar comparables and the inclusion of non-comparable companies.

The TPO independently conducted a fresh selection of comparables, identifying 13 companies with an average margin of 43.01 per cent. Of the four comparables initially proposed by the respondent/assessee, the TPO accepted three and rejected one.

Based on the average margin of the selected comparables, the TPO proposed an upward adjustment to the arm's length price (ALP), which was subsequently incorporated into the draft assessment order dated December 31, 2014.

The assessee filed an application with the Dispute Resolution Panel (DRP). Upon the DRP's order, the TPO instructed the assessee to provide a risk adjustment calculation for two comparables, namely IM+ Capital and Keynote Corporate Services Limited, and a working capital adjustment. However, the assessee requested that the TPO complete this process independently.

In accordance with the DRP’s recommendations, the TPO implemented working capital adjustments and recalculated the arm's length price, resulting in an Assessment Order with an assessed income of ₹23,78,88,160 after applying additions and adjustments of ₹11,82,53,407, as opposed to the previous adjustments of ₹13,79,85,005.

The assessee challenged the Assessment Order before the Tribunal, which issued a ruling on May 17, 2019. Subsequently, upon receiving a miscellaneous application filed by the assessee, the Tribunal recognised rectifiable errors and consequently recalled the appeal order for a limited scope review, specifically addressing five grounds primarily related to the applicability of certain filters in comparable selection and risk adjustment. After hearing arguments from both parties, the Tribunal issued its decision.

The department argued that the selection of comparables for determining the arm's length price of an international transaction requires a case-by-case approach, and the Tribunal erred by excluding certain comparables solely based on the judgment of the jurisdictional High Court in a previous case involving the respondent/assesse for AY 2007-08 to 2009-10.

The Court concluded that the appellant/department failed to establish any material changes in the circumstances of the assessee or any of the comparables during the financial year in question compared to the earlier years. The department did not provide any evidence or arguments suggesting such changes, necessitating a fresh comparability analysis.