Comprehensive Analysis of ITAT Bangalore Ruling on Transfer Pricing Filters: Turnover, RPT, and Functional Comparability

The determination of the Arm’s Length Price (ALP) in international transactions often leads to complex litigation, primarily revolving around the selection or rejection of comparable companies. The Income Tax Appellate Tribunal (ITAT), Bangalore Bench, recently delivered a significant ruling in the case of Etisalat Software Solutions Pvt. Ltd. Vs DCIT. This decision provides critical insights into the application of various Transfer Pricing (TP) filters, including the turnover filter, the Related Party Transaction (RPT) filter, and the criteria for functional comparability.

This article provides a detailed summary and legal analysis of the Tribunal's order, focusing on the principles established for benchmarking international transactions under the Income Tax Act 1961.

Factual Matrix of the Dispute

The assessee, Etisalat Software Solutions Pvt. Ltd., operates as a subsidiary of Emirates UAE. Its primary business involves providing software development services to its Associated Enterprise (AE). For the Assessment Year (AY) 2017-18, the assessee filed its return of income declaring a total income of Rs. 22,43,89,580.

During the year, the assessee engaged in the following international transactions with its AE:

  • Software development services amounting to Rs. 2,848,331,417
  • Reimbursement of expenses amounting to Rs. 153,481,812

To benchmark these transactions, the assessee adopted the Transactional Net Margin Method (TNMM) as the most appropriate method. The Profit Level Indicator (PLI) was computed as Operating Profit over Operating Cost (OP/OC). The assessee's TP documentation reported an operating margin of 10.92%. By selecting 17 comparable companies with a median margin of 9.22%, the assessee concluded that its international transactions were at arm's length.

The Transfer Pricing Officer's Adjustments

The case was selected for scrutiny, and a notice under Section 143(2) was issued. Consequently, the matter was referred to the Transfer Pricing Officer (TPO) to determine the ALP of the international transactions.

The TPO rejected 12 out of the 17 comparables selected by the assessee and conducted an independent search, introducing 15 new companies into the comparability matrix. This aggressive restructuring of the comparable set resulted in a revised median margin of 26.18%. Consequently, the TPO proposed a massive TP adjustment of Rs. 38,26,58,668.

The Assessing Officer (AO) incorporated this adjustment into the draft assessment order. The assessee subsequently filed objections before the Dispute Resolution Panel (DRP), which upheld the TPO's methodology and confirmed the adjustment. The final assessment order was passed under Section 143(3) read with Section 144C(13) of the Income Tax Act 1961, prompting the assessee to appeal before the ITAT.

The core of the litigation before the Tribunal centered on the validity of the comparables chosen by the TPO. The assessee challenged the inclusion of several companies based on specific filters.

1. Application of the Turnover Filter

The assessee argued that 15 companies in the TPO's final set should be excluded because their turnover was either exceptionally high or abnormally low compared to the assessee's turnover of approximately Rs. 284 crore. The TPO had included industry giants like Infosys Ltd. (turnover of Rs. 59,289 crore) and extremely small entities (turnover below Rs. 5 crore).