High Court dismisses tax dept’s appeal on transfer pricing - ITAT’s factual findings upheld

Get the full picture - access the original judgement of the court order here

Case Name

Principal Commissioner of Income Tax Vs. 3i India Ltd. (High Court of Bombay)

Income Tax Appeal No. 1916 of 2017

Date: 15th November 2021

Key Takeaways

• Factual findings by ITAT are generally not appealable unless there’s clear perversity or legal error
• Transfer pricing adjustments are essentially matters of estimation based on comparable analysis
• Courts discourage “ritualistic appeals” by tax authorities on transfer pricing matters without substantial legal questions
• Investment advisory services don’t automatically include portfolio management services - evidence is required to prove additional services
• Selection of comparables is primarily a factual exercise that courts won’t interfere with unless there’s demonstrated error

Issue

Whether the ITAT was correct in:

1. Treating the assessee’s activity as mere investment advisory services rather than portfolio management services
2. Including/excluding certain companies as comparables for transfer pricing analysis

Facts

• Assessment Year: 2010-2011
• Company: 3i India Ltd filed its tax return on October 7, 2010, declaring income of Rs. 12.52 crores
• Transfer Pricing Issue: Since the company’s international transactions with associated enterprises exceeded Rs. 15 crores, the case was referred to the Transfer Pricing Officer (TPO)
• TPO’s Action: The TPO made an upward adjustment of Rs. 19.55 crores on account of performance fees and investment advisory fees on January 30, 2014
• Assessment Process: The Assessing Officer issued a draft assessment order, which the company challenged before the Dispute Resolution Panel (DRP). The DRP partially allowed the objections, and the final assessment was completed on December 29, 2014
• ITAT Appeal: 3i India appealed to ITAT, which allowed their appeal on September 16, 2016

Arguments

Tax Department’s Arguments (7 questions raised):

The revenue raised 7 substantial questions of law, which can be split into two parts:

Part 1 (Questions a-e):

• The company provided portfolio management services (PMS) in addition to investment advisory services
• ITAT ignored the TPO’s analysis and regulatory definitions
• ITAT wrongly relied on internal company nomenclature
• ITAT didn’t consider uncontrolled rates for PMS activities
• ITAT incorrectly relied on APA (Advance Pricing Agreement) for subsequent years

Part 2 (Questions f-g):

• ITAT wrongly included certain comparables (Kinetic Trust Ltd, IDC India Ltd, Future Capital Investment Advisors Ltd) despite turnover differences and the company’s own exclusion of these in subsequent years

3i India’s Position:

• They only provided investment advisory services, not separate portfolio management services
• The functions performed were covered under the “Investment Advisory Agreement” with associated enterprises
• The selected comparables were appropriate for benchmarking their transactions

Key Legal Precedents

The court relied on several important precedents:

1. Pr. Commissioner of Income Tax-6 Vs. M/s Eight Roads Investment Advisors Pvt Ltd. - The court quoted paragraph 12 extensively, establishing that transfer pricing is “essentially a matter of estimate of the fair value” and involves “broad and fair guess-work” based on factual materials
2. The Pr. Commissioner of Income Tax-1 Vs. Barclays Technology Centre India Pvt Ltd. - This unreported judgment established that findings on comparables are “entirely one of fact” and revenue must show perversity to challenge them
3. Principal Commissioner of Income Tax-9 v. WSP Consultants India § Ltd. 253 Taxman 58 (Delhi) - The Delhi High Court observation that “Any inclusion or exclusion of comparables per se cannot be treated as a question of law unless it is demonstrated to the Court that the Tribunal or any other lower authority took into account irrelevant consideration”

Statutory Provisions Referenced:

• Section 143(3)(1) of the Income Tax Act 1961
• Section 143(2)
• Section 142(1)
• Section 92CA(3)
• Section 144C(1)
• Section 144C(13)
• Rule 10B of the Income Tax Rules, 1961

Judgement

Winner: 3i India Ltd. (Respondent)

Court’s Reasoning:

On Part 1 (Questions a-e):

The court held that ITAT made a factual finding that there was no evidence of 3i India rendering portfolio management services in addition to investment advisory services. The ITAT correctly concluded that no separate PMS benchmarking was needed as it was “part and parcel of rendering of investment advisory services” under the Investment Advisory Agreement.

On Part 2 (Questions f-g):

The court found that ITAT’s findings on comparables were “entirely one of fact” and the revenue failed to show any perversity. The revenue couldn’t demonstrate that ITAT’s analysis in excluding/including companies was contrary to settled legal principles.

Key Legal Principle:

The court emphasized that transfer pricing adjustments are “nothing but a matter of estimate of a broad and fair guess-work” based on factual materials, and such factual findings shouldn’t be interfered with unless there’s clear perversity.

Orders Made:

• Appeal dismissed with no order as to costs
• Court directed revenue counsel to serve copy of order on Law Secretary, CBDT, Principal Chief Commissioner, and CIT (Judicial) for necessary action
• Court criticized the “ritualistic manner” of filing such appeals

FAQs

Q1: What does this case mean for other transfer pricing disputes?

A: This case reinforces that courts won’t interfere with ITAT’s factual findings on comparables unless there’s clear legal error or perversity. It discourages routine appeals on transfer pricing matters.

Q2: Can investment advisory services include portfolio management services automatically?

A: No, the court clarified that evidence is required to prove that additional services like portfolio management were actually provided beyond investment advisory services.

Q3: What’s the significance of the court’s criticism of “ritualistic appeals”?

A: The court is sending a strong message to tax authorities to be more selective in filing appeals and only challenge decisions where there are genuine legal issues, not just factual disagreements.

Q4: How does this affect the selection of comparables in transfer pricing?

A: The case confirms that selection of comparables is primarily a factual exercise. Revenue authorities need to show clear perversity or legal error to successfully challenge ITAT’s decisions on comparables.

Q5: What should companies learn from this case?

A: Companies should maintain clear documentation of the actual services provided and ensure their transfer pricing documentation accurately reflects the functions performed under their agreements with associated enterprises.

Q6: Why did the court direct copies to be sent to senior tax officials?

A: The court wanted to ensure that senior officials review the pattern of filing appeals without substantial legal grounds, hoping to reduce such “ritualistic” litigation.

1. Appellant is impugning an order dated 16th September 2016 passed by

the Income Tax Appellate Tribunal (ITAT), Mumbai.

2. Respondent filed its return of income on 7th October 2010 for A.Y.-

2010-2011 declaring income of Rs.12,52,11,166/-. The return was

processed under Section 143(3)(1) of the Income Tax Act 1961 (the Act) on

14th April 2011 accepting the declared income. After scrunity assessment

notice under Section 143(2) was issued on 19th September 2011, notice

under Section 142(1) alongwith questionnaire was also issued to

respondent on 20th December 2013 seeking further details. As the

international transaction with Associate Enterprises (AE) entered into by

respondent exceeded the threshold limit of Rs.15 crores, a reference to the

Transfer Pricing Officer (TPO) was made after the approval of CIT-8,

Mumbai for computing the arms’ length price of international transaction.

In this case, the TPO made an upward adjustment of Rs.19,55,13,736.73 on

Meera Jadhav account of performance fees and investment advisory fees, vide order dated 30th January 2014 passed under Section 92CA(3). The Assessing Officer based on the order of TPO passed a draft assessment order dated 28th

February 2014 under Section 144C(1) of the Act. Respondent filed its

objections before the Dispute Resolution Panel (DRP) against the draft

assessment order. The DRP after considering objections filed by respondent,

by an order dated 13th November 2014 partly allowed the objections. The

Assessing Officer, as per directions of DRP passed the assessment order

dated 29th December 2014 under Section 143(3) read with Section

144C(13) of the Act.

3. Aggrieved by this order, respondent filed an appeal before ITAT and

ITAT was pleased to allow the appeal by an order dated 16th September

2016. It is this order, which is impugned in the appeal and the following 7

substantial questions of law have been proposed:

(a) Whether the Ld. ITAT is right holding the activity of the assessee to

be mere investment Advisory activity ignoring the PAR analysis done

by the TPO ?

(b) Whether the Ld ITAT is right in accepting the internal

nomenclature of the assessee and thereby ignoring the definitions of

“investment advisory” as provided in the SHIM Regulations and also

ignoring the functions and risks/liabilities associated with directorship

of a company which has been relied upon by the IPO in the FAR

analytic ?

(c) Whether the Ld. ITAT is right in holding that no comparable has

been provided for the CUP analysis ignoring the fact that the

uncontrolled rates for such activity has been mentioned by the TPO in

the order ?

(d) Whether the Ld. ITAT is right in not considering the uncontrolled

rates for the PMS activity of the assessee which have been submitted

by the assessee before it and stated to be having sanction of the

Hon’ble High Court of Bombay ?

(e) Whether the Ld. ITAT is right in relying on the APA signed by the

assessee with CBDT for subsequent years when the same are clearly

not applicable for the relevant year, ignoring the fact that the assessee

had the option of including the relevant year for APA as Ivell and has

not opted for the same ?

(f) Whether the Ld ITAT is right in directing the inclusion of 3

comparables in the TNMM analysis relying solely on a decision of the

Ld. ITAT in a completely different ease without examining the

applicability of the same to the facts of the assessee’s case.

Whether the Ld. ITAT is right in directing inclusion of the comparable

M/s Kinetic Trust Ltd. ignoring the huge turnover difference between

the assessee and the comparable ?

(g) Whether the Ld. ITAT is right in directing inclusion of the

comparable M/s. IDC India Ltd. and M/s Future Capital Investment

Advisors Ltd even though the assessee has considered the same to be

non comparable for the year (AY.2010-2011) in its Transfer Pricing

Study Report for subsequent years, which include analysis for the

AY.2010-2011 as well ?

These 7 questions of law can be split into two parts, namely (a) to (e)

in Part-1 and (f) and (g) in Part-2.

4. We have heard Mr. Suresh Kumar and Mr. Joshi and with their

assistance considered the order of ITAT.

5. As regards first part, i.e., (a) to (e) are on the basis that respondent,

in addition to investment advisory services, had also rendered portfolio

management services (PMS). The ITAT in the impugned judgment, has

come to a finding of fact that there was no evidence of respondent rendering

any such additional services. The ITAT has further held that no separate PMS

services needs to be benchmarked as the same is part and parcel of

rendering of investment advisory services which is evident from the

functions performed in terms of the “Investment Advisory Agreement”

entered between respondent and its AE. Therefore, the said 5 questions (a)

to (e) cannot be entertained.

6. As regards second part, i.e., (f) and (g) are concerned, the finding of

the ITAT is entirely one of fact and the revenue has failed to show as to how the finding arrived at by the ITAT is perverse in any manner. The revenue has also not been able to demonstrate that the analysis done by the ITAT while excluding the companies suggested by the revenue from the list of

comparables, was in any manner contrary to the settled position in law.

7. The entire exercise of making transfer price adjustment on the basis of

comparables is nothing but a matter of estimate of a broad and fair guess-

work of the authorities based on factual relevant material brought before

the authorities, i.e., TPO, DRP and the Tribunal which are the fact finding

authorities. It will be useful to reproduce paragraph 12 of judgment of this

court in Pr. Commissioner of Income Tax-6 Vs. M/s Eight Roads Investment

Advisors Pvt Ltd.

“12. In view of the above detailed reproduction of the reasonings

given by the Tribunal we find that, while undertaking the exercise to

arrive at the arm’s length price which is essentially a matter of

estimate of the fair value which the Indian Company had paid or had

received from its Associate Enterprise (A.E.), such exercise is required

to be undertaken by the TPO on the basis of the facts and figures

relating to comparable cases of other similarly placed entities, whose

relevant data is available in the public domain. As per the provisions

of the Act and the Rules, the assessee company is required to furnish

its own Transfer Pricing Analysis and the list of chosen comparables

which may or may not be agreed to by the Revenue Authorities and

they would introduce some more comparables rejecting the

comparables given by the assessee company by applying certain filters

like Related Party Transactions (RPT) filter, turnover filter, export

earnings filter, employee cost filter, etc to bring them within the

comparable range of the cases of such comparables and generally

there would be a tug of war between the assessee and the revenue in

such a situation. We would state that the assessee company would

normally choose comparables, whose operating profit margins are less

or only little more than the assessee, but the revenue would bring in

comparables with higher profit margins. The TPO, may in the case of

an assessee introduce and suggest comparables whose operating

margins are higher than the assessee company so as to make transfer

pricing adjustments in the declared income of the assessee, resulting

in fetching of more revenue. From the aforesaid quoted paragraphs

from the Tribunal’s order, it is evident that, individual cases of such

comparables have been juxtaposed with the functionality of the

assessee considered, analyzed and discussed by the Tribunal in respect

of comparables which were excluded by the TPO as also in the case of

those comparables which were included by the TPO. It is quite

common to note that, while some comparables are found to be

appropriate and really comparable to the facts of the assessee

company, some are not and it would ultimately result in whether the

correct filters have been properly applied or not or whether the most

appropriate method of determination of arm’s length price has been

adopted or not to make fair and reasonable transfer pricing

adjustments in the hands of the assessee. However, the entire exercise

of making transfer pricing adjustments on the basis of comparables is

nothing but a matter of estimate of a broad and fair guess-work of the

authorities based on factual relevant materials brought before the

authorities i.e. the TPO, the DRP and the Tribunal, which are the fact

finding authorities.”

(emphasis supplied)

8. It would be apposite to reproduce paragraphs 5, 6 and 7 of an

unreported judgment of this court in The Pr. Commissioner of Income Tax-1

Vs. Barclays Technology Centre India Pvt Ltd.

which read as under:

“5 In the above view, the finding of the Tribunal is entirely one of the

fact and the Revenue has failed to show as to how the finding arrived

at by the Tribunal is perverse in any manner. Nor has the Revenue

even attempted to demonstrate that analysis done by the Tribunal

while excluding the aforesaid four companies from the list of

comparables, was in any manner contrary to the settled position in

law. Thus, we see no reason to entertain this appeal.

6. However, before closing, we would like to record the fact that we

find that the Revenue is regularly filing appeals from the orders of

the Tribunal in respect of Transfer Pricing particularly with regard to

exclusion and inclusion of certain companies as comparables to

determine ALP of tested parties. These appeals are being filed in a

ritualistic manner. This results in the orders of the Tribunal which are

essentially findings of fact in respect of exclusion/inclusion of a

comparable being challenged without pointing out in any manner

perversity of finding or failure to adhere to the settled principles of

law while determining comparables such as Rule 10B of the Income

Tax Rules, 1961. This unnecessarily takes up the scarce time of the

Court. The Revenue and the Assessee would do well to bear in mind

observations of the Delhi High Court in Principal Commissioner of

IncomeTax9 v. WSP Consultants India (P) Ltd.253 Taxman 58 (Delhi)

wherein it has been observed:

“10. Any inclusion or exclusion of comparables

per se cannot be treated as a question of law

unless it is demonstrated to the Court that the

Tribunal or any other lower authority took into

account irrelevant consideration or excluded

relevant factors in the ALP determination that

impact significantly.”

7. We hope the above observations would be kept in mind both by the

Revenue and the Assessee who seek to prefer appeals from the orders

of the Tribunal on Transfer Pricing particularly inclusion/exclusion of

comparables. The Commissioner of Income Tax and the Assessee in

general would do well to also review the appeals filed and withdraw

the same, in case the only challenge therein is to finding of facts, if

the same is without evidence of any perversity or is in the face of

settled legal position. The counsel of the Revenue is directed to serve

a copy of this order on the Principal Chief Commissioner of Income

Tax within the State of Maharashtra for necessary action.”

(emphasis supplied)

9. In our view, the ITAT has not committed any perversity or applied

incorrect principles to the given facts and when the facts and circumstances

are properly analysed and correct test is applied to decide the issue at hand, then, we do not think that questions as pressed raises any substantial

questions of law.

10. The appeal is devoid of merit and is dismissed with no order as to

costs.

11. We have to note that this is one more appeal filed in a ritualistic

manner which has unnecessarily taken up the scarce time of this court. The

Commissioner of Income Tax and CIT(Judicial) would do well to review all

appeals filed and withdraw the same, in case the only challenge therein is to finding of facts and there is no evidence of perversity or in the fact of settled legal position. The Counsel of Revenue is directed to serve a copy of this order on the Law Secretary (Government of India), Central Board of Direct Taxes, Principal Chief Commissioner of Income Tax (Maharashtra) and CIT (Judicial) for necessary action.

(AMIT B. BORKAR, J) (K.R. SHRIRAM, J.)