“Comparability” & “tolerance band” adjustments u/s 92C – Important Principles Explained

CLR Editorial Notes: The Tribunal had to consider the following transfer pricing issues:

(i) whether the use of multi-year data for determining ALP is permissible?

(ii) Whether +/-5% adjustment is a standard deduction?

(iii) Whether companies with minor differences can be treated as non-comparable?

(iv) Whether a company with turnover 20 times that of the assessee can be said to be comparable?

(v) Whether as the assessee was operating in a risk-free environment, adjustment for valuable intangibles and entrepreneurial risk borne by the comparables has to be made?

(vi) Whether the TPO/AO need to demonstrate the assessee™s motive to shift profits outside India by manipulating prices charged in international transactions?

The Tribunal Held:

“(i) The expression shall in Rule 10B(4) makes it clear that it is mandatory to use the current year data first and if any circumstances reveal an influence on the determination of ALP in relation to the transaction being compared than other data for period not more than two years prior to such financial year may be used. If the current year™s data of comparables is not available at the time of filing the ROI a fresh search of comparables during the transfer pricing proceedings is permissible;

(ii) The +/-5% tolerance band in s. 92C is not a standard deduction. If the arithmetic mean falls within the tolerance band, then there should not be any ALP adjustment. If it exceeds the said tolerance band, ALP adjustment is not required to be computed after allowing the deduction at 5%. That means, actual working is to be taken for determining the ALP without giving deduction of 5%;

(iii) The argument that a company with employee-cost of 1.38% of its revenue and with intangible property is not comparable because the assessee has an employee-cost of 52.12% and has no intangible property is not acceptable because the differences do not materially affect the price or profit earning. No two comparable companies can be replicas of each other. Rule 10B has to be applied not with technical rigor, but on a broader prospective; 

(iv) A company with 20 times turnover (Wipro BPO) more than the assessee is not at all comparable because the assessee is a pygmy compared to a giant. Accordingly Wipro BPO has to be excluded from the list of comparable companies;

(v) There are several factors such as market risks, environmental risk, entrepreneurial risk and functional risk etc., which affect this matter and which ultimately affect the results of the company. These factors make it impracticable to find out exact duplicate of the assessee as comparable. Some variation is bound to exist. The TPO had identified comparables whose functions were similar to the assessee by applying quantitative and qualitative filters to eliminate differencesbetween the assessee and the comparable to neutralize the risk factors. The assessee™s argument that it is a low end performer operating in risk-free environment and that suitable adjustment should be made is not acceptable;

(vi) The transfer pricing rules apply when one of the parties to the transaction is a non-resident, even if the transaction takes place within India. There is no need to find out the legislative intent behind the transfer pricing provision when the provisions were unambiguous. The existence of actual cross border transactions or motive to shift profits outside India or to evade taxes is not a pre-condition for transfer pricing provisions to apply.”