ITAT Bangalore Upholds Rs. 200 Crore Turnover Filter for TP Comparability and Allows Interest Deduction on CCDs

The Income Tax Appellate Tribunal (ITAT), Bangalore Bench, recently delivered a comprehensive ruling in the case of TE Connectivity Services India Private Limited Vs National Faceless Assessment Centre. The judicial decision for Assessment Year 2017-18 provides significant clarity on multiple contentious tax issues, primarily focusing on the application of turnover filters in transfer pricing assessments, the characterization of Compulsorily Convertible Debentures (CCDs) for interest deductibility, and the treatment of expenditure related to Restricted Stock Units (RSUs).

This ruling underscores the principle that accounting entries mandated by the Indian Accounting Standards (Ind AS) do not override statutory provisions under the Income Tax Act 1961 when determining the allowability of business expenditures.

1. Factual Matrix of the Assessment

The assessee, incorporated as a wholly-owned subsidiary of Tyco Electronics Singapore Pte Ltd (ultimately held by TE Connectivity Ltd., Switzerland), operates as a captive service provider. Its primary business involves rendering Information Technology Enabled Services (ITeS), encompassing shared services in human resources, finance back-office, customer support, and information technology, to its Associated Enterprises (AEs) globally.

For the Assessment Year 2017-18, the assessee filed its return of income, which was subsequently scrutinized. The National Faceless Assessment Centre passed the final assessment order under Section 143(3) read with Section 144C(13) and Section 144B of the Income Tax Act 1961, incorporating significant additions proposed by the Transfer Pricing Officer (TPO) and upheld by the Dispute Resolution Panel (DRP). The assessee challenged these additions before the ITAT.

2. Transfer Pricing Dispute: The Application of Turnover Filters

The primary grievance of the assessee concerned the transfer pricing adjustment made to its ITeS segment. To benchmark its international transactions, the assessee applied the Transactional Net Margin Method (TNMM) as the most appropriate method, utilizing the Operating Profit on Total Cost (OP/TC) as the Profit Level Indicator (PLI).

The assessee reported an operating revenue of Rs. 64.45 crore against an operating cost of Rs. 54.37 crore, resulting in an operating profit of Rs. 10.08 crore and an OP/TC margin of 18.54%. Based on its transfer pricing study comprising eleven comparable companies with a median margin of 10.89%, the assessee concluded that its international transactions were at arm's length.

The TPO rejected this analysis. Upon re-computation, the TPO determined the assessee's operating revenue at Rs. 64.54 crore and revised the operating cost to Rs. 56.07 crore. This revision involved deducting bank charges of Rs. 0.0089 crore, corporate social responsibility (CSR) expenses of Rs. 0.0207 crore, and finance costs of Rs. 1.56 crore. Consequently, the TPO calculated the assessee's operating profit at Rs. 8.37 crore, yielding a revised PLI of 14.92%.

The TPO then selected a fresh set of thirteen comparable companies. The weighted average OP/TC margins of these companies were recorded as follows: Sundaram Business Services Ltd at 2.08%, Jindal Intellicom Ltd at 7.41%, Fuzen Software Pvt Ltd at 15.93%, Microland Ltd at 17.53%, Tech Mahindra Business Services Ltd at 22.37%, Datamatics Business Solutions Ltd at 22.64%, Infosys BPM Services Ltd at 24.37%, Vitae International Accounting Services Pvt Ltd at 27.13%, Manipal Digital Systems Pvt Ltd at 27.41%, CES Ltd at 29.00%, Ultramarine & Pigment Ltd at 34.41%, SPI Technologies India Pvt Ltd at 36.95%, and Inteq BPO Services Pvt Ltd at 39.51%. The statistical analysis of this set yielded a 35th percentile of 22.37%, a median of 24.37%, and a 65th percentile of 27.41%.

Based on these figures, the TPO proposed a substantial adjustment, which was documented in the order as follows:

"20.4.1 The median of the weighted average Profit Level Indicators is taken as the A Length margin. Please see Annexure-A for details of computation of PLI of the comparabl Based on this, the Arm's Length Price of the services rendered by the Taxpayer to its A is computed as under: ITeS SEGMENT Particulars Formula Amount (in Rs.) Taxpayers operating revenue OR 64,45,04,000 Taxpayers operating cost OC 56,07.00,000 Taxpayers operating profit OP 8,37,04,000 Taxpayers PLI PLI=OP/O C 14.92% . 35th Percentile Margin of comparable set Yes Adjustment Required (if PLI< 35th Percentile) 22.37% Median Margin of comparable set M 24.37 Arm's Length Price ALP=(1+ M) OC 69,73,42,590 Price Received OR 64.45.04.000 Shortfall being adjustment ALP-OR 5,28,38,590 20.4.2 The above shortfall of Rs.5,28,38,590/- is treated as transfer pricing adjustment u/s 92CA in respect of IT enabled servicesegment of the taxpayer's international transactions."

The DRP provided partial relief by directing the inclusion of bank charges as operating in nature, verifying the margins of certain comparables, including Crystalvoxx Ltd and Suprawin Technologies Limited, and excluding Ultramarine and Pigment Limited. However, the core adjustment remained largely intact in the final assessment order.

(i) Tribunal's Evaluation of Transfer Pricing Comparability

Before the ITAT, the assessee argued that companies with excessively high turnovers could not be functionally compared to a captive service provider with a modest turnover of Rs. 64.45 crore. The assessee advocated for an upper turnover filter of Rs. 200 crore, pointing out that the TPO had applied a lower turnover filter of Rs. 1 crore but illogically ignored an upper ceiling.

The Tribunal examined a plethora of judicial precedents regarding turnover-based comparability. It noted the conflicting views between different High Courts, specifically referencing the Delhi High Court's decision in Chriscapital Investment Advisors (India) Pvt. Ltd. and the Bombay High Court's decision in CIT Vs Pentair Water India Pvt. Ltd. The Tribunal also reviewed contrary decisions from the Mumbai ITAT in Willis Processing Services and Capgemini India Pvt. Ltd., as well as other rulings in NTT Data, Societe Generale Global Solution Centre, and LSI Technologies.