Karnataka High Court Upholds Exclusion Of Infosys, Wipro, Tata Elxsi As Transfer Pricing Comparables

The Karnataka High Court on 28 October dismissed the Income Tax Department's appeal against the exclusion of Infosys, Wipro and Tata Elxsi from the comparables selected to determine the arm's length price (ALP) of software development services provided by Logica Private Limited.

A Bench comprising Chief Justice Vibhu Bakhru and Justice K.S. Hemalekha held that companies with significant brand value, intellectual property rights and materially different business profiles cannot be treated as comparable for transfer pricing merely because they operate in the software sector. The judges said:

“The Revenue's contention that the brand is not the only variable affecting revenue is correct. However, it cannot be disputed that it is an asset that would have a bearing on profit margins. Thus, we find no perversity in the learned ITAT's decision to reject Infosys and Wipro as comparables, inter alia, on the ground that they hold valuable IPR and have an established brand.”

The dispute arose in Assessment Year 2007-08, when Logica provided software development and consultancy services and entered into international transactions with its associated enterprises. The Assessing Officer referred the matter to the Transfer Pricing Officer (TPO) to determine the ALP.

The TPO rejected Logica's transfer pricing study and applied the Transactional Net Margin Method (TNMM), proposing an adjustment of Rs. 39.73 crore, comprising Rs. 38.20 crore for software development services and Rs. 1.52 crore for support services.

The Dispute Resolution Panel upheld the adjustment. However, the Income Tax Appellate Tribunal (ITAT) accepted several of Logica's objections and excluded certain companies from the comparables. The Revenue challenged these exclusions, the use of segmental financials and the application of a 15% related-party transaction (RPT) filter.

The High Court found no reason to interfere with the ITAT's findings on functional differences between Logica and the companies selected by the TPO.

It noted that Accel Transmatic was engaged in manufacturing kiosks and providing embedded software, training and animation services. Avani Cincom Technologies had developed its own software product, “DXchange”, while Lucid Software and KALS Information Systems also derived revenue from software products and other activities.

Celestial Labs operated in pharmaceutical and biotechnology research, drug discovery and customised IT solutions. The Bench found that the absence of reliable segmental financial information further supported its exclusion from the comparables.

On Infosys and Wipro, the judges rejected the Revenue's contention that brand value and company size were irrelevant to transfer pricing. It noted that Infosys held substantial intangible assets, had a brand value of Rs. 22,915 crore and earned revenue exceeding Rs. 13,145 crore.

It also incurred significant expenditure on advertising, promotion and research and development. Logica, by contrast, was considerably smaller and primarily provided services to its associated enterprises.

Further, the Bench observed that an established brand and goodwill could influence the prices charged and profit margins earned by a company. Differences in size, business profile, cost structure and research and development expenditure could also affect comparability under the TNMM.

It upheld the exclusion of Tata Elxsi, noting that its activities included embedded systems, product design, engineering services and system integration, which differed from Logica's software development services.

On segmental financials, the judges held that where a company undertakes multiple activities, the profit margin of the segment comparable to the tested entity should be considered instead of the company's overall enterprise-level margin.

They also noted that the TPO could obtain segmental information by issuing notices under Section 133(6) of the Income Tax Act, provided the information was credible and properly verified.

Moreover, the Bench upheld the ITAT's decision to apply a 15% RPT filter instead of the 25% threshold adopted by the TPO. It noted that the TPO had not provided specific reasons for selecting the higher threshold and that sufficient comparables remained available after applying the 15% filter.

It also held that issues concerning the allocation of recruitment, travel and conveyance expenses under Section 10A of the Income Tax Act had already been addressed in an earlier decision.

Accordingly, the High Court dismissed the Revenue's appeal.

For Petitioner: S.K. Devi, M.R. Raj Mohan, Santhosh P.A. Abraham and Shanmugham D. Jayan, Advocates 

For Respondent: Sindhu Santhalingam, Senior Government Pleader