The Karnataka High Court has said that a Transfer Pricing Officer (TPO) cannot refuse comparable companies chosen by a taxpayer only to supersede them with a standard set of comparables chosen by the Income Tax Department, holding that the selection or exclusion of comparables should fulfil the provisions under the Income Tax Act and Rule 10B of the Income Tax Rules.
A Division Bench of Justices S.G. Pandit and K.V. Aravind allowed a series of transfer pricing appeals, including a petition by SAP Labs India Private Limited.
Remanding the issue, the Bench held that the Transfer Pricing Officer (TPO) must strictly justify including or excluding comparable companies under the statutory provisions of the Income Tax Act and its corresponding rules.
“The selection or exclusion of comparables is essentially a factual and data-driven exercise, and the TPO cannot reject the taxpayer’s comparables merely to substitute them with a standard departmental set. Such determination must strictly conform to the requirements of Rule 10B of the Rules.”
Previously, the appeals had reached the Apex Court, which remitted the cases to the HC for fresh consideration. The Apex Court asked the HC to analyse whether the statutory provisions regulating transfer pricing had been adhered to and whether the findings of the income tax appellate tribunal were unreasonable.
The HC said that Chapter X of the Income Tax Act furnishes a self-contained structure for transfer pricing. The responsibility of deciding the Arm’s Length Price and maintaining the specified documents is on the taxpayer; the TPO can interface with the taxpayer’s determination merely after fulfilling the conditions specified u/s 92C(3) of the Income Tax Act, which allows the assessing officer to overlook the taxpayer’s calculation of the Arm’s Length Price in particular situations.
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It then expressed that when the TPO denies the taxpayer’s transfer pricing determination and supersedes other comparables, the burden transfers to the TPO to justify the inclusion or exclusion of those companies.
The bench, regarding the turnover filter, has mentioned that an upper turnover limit of Rs 200 crore was rational and legally sustainable. It said that the turnover, brand value, economies of scale, bargaining power, and ownership of intangible assets may materially impact the comparability and profitability of companies.
A 15% Related Party Transaction (RPT) filter shall usually be chosen. A higher limit of 20% or 25% can be adopted only if it is specifically recorded that sufficient comparable companies meeting the lower limit are unavailable.
Concerning foreign exchange gains and losses, the Bench mentioned that they can be considered as operating items where there is a connection with the international transaction.
In the absence of this connection, foreign exchange gains or losses cannot be included in operating revenue or operating cost.
U/s 92C of the Income Tax Act, the ±5% range is an allowable variation rather than a standard deduction, it clarified. When the variation surpasses the statutory limit, a transfer pricing adjustment is required.
Therefore, on the grounds of the statutory criteria and relevant data, the HC said that transfer pricing comparables should be selected or excluded. It cannot be substituted only because the department chooses a standard set of comparable companies.
| Case Title | SAP Labs India Private Limited vs. Income Tax Officer & Connected Matters |
| Appeal No. | INCOME TAX APPEAL No.10 OF 2011 |
| For the Petitioner | Sri. D.D. Nageshwar Rao |
| For the Respondent | Sri. N. Venkataraman, Sri. E. I. Sanmathi, Sri. Sushal Tiwari and Sri. M. Dilip |
| Karnataka High Court | Read Order |
