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Introduction
1. Turnover and RPT filter plays a vital role in selecting a comparable company while preparing transfer pricing study report. This article attempts to summarize the importance of the turnover and RPT filter, how to apply them and various legal views passed in the context of turnover and RPT filter.
Importance of Turnover & RPT Filter
2. ICAI TP Guidance note on transfer pricing clearly lays down the importance of turnover filter. It says that a transaction entered into by a Rs.1,000 crore company cannot be compared with the transaction entered into by a Rs 10 crore company. The two most obvious reasons are the size of the two companies and the relative economies of scale under which they operate. The above two reasons appears to be very valid and thus for a proper TP analysis one needs to certainly apply the turnover filter. Having understood the importance of turnover filter the next question that arises is what should be the appropriate turnover filter. Well we will answer this question in the subsequent part of this article. Let us also try to analyze the importance of RPT filter in selecting a comparable.
While conducting transfer pricing analysis we try to compare the related party transaction undertaken by the assessee with the uncontrolled transactions undertaken by the comparable and thus arrive at a conclusion as to whether the transaction benchmarked is at arm’s length or not. What if the comparable selected itself has undertaken significant controlled transaction. If a chosen company, though functionally comparable, has entered into international transactions beyond a particular percentage with the related parties, it is quite possible that its overall profit may have been distorted due to such transactions rendering it as incomparable. That is why, this filter is applied to make certain that a company sought to be considered as comparable should have its profit uninfluenced by the impact of the related party transactions. Thus RPT filter is also a significant criteria to be considered while selecting a comparable.
What should be the appropriate RPT Filter?
3. In the case of Ariba Technologies India (P.) Ltd. v. ITO [2016] 67 taxmann.com 265 (Bang-Trib.)the ITAT held that finding comparables having zero per cent RPT transaction is impossible and therefore a reasonable tolerance range has to be considered for selecting uncontrolled comparables. The tolerance range is dependent on the availability of comparables. Thus if comparables are easily available tolerance range of RPT should be restricted to minimum.
In this case the assessee has selected 18 comparables and the TPO has selected 26 comparables. Therefore it appears that the comparables are easily available. When comparable are easily available then the RPT cannot be allowed to the extreme limit of 25 per cent of revenue. Thus the ITAT directed to apply the threshold limit of not more than 15 per cent.
Furthermore in case of Dy. CIT v. Synopsis India (P.) Ltd. [2015] 64 taxmann.com 110 (Bang-Trib.), 24/7 Customer.com v. Dy. CIT [2013] 140 ITD 344/[2012] 28 taxmann.com 258 (Bang.) it has been held that 15% RPT filer is appropriate. However in case of United Online Software Development (India) (P.) Ltd. [2014] 44 taxmann.com 424 (Hyd-Trib.), Cordys R & D (India) (P.) Ltd. [2014] 43 taxmann.com 64/149 ITD 587 (Hyd. – Trib.) 25% is taken as the appropriate filter.
How to compute RPT filter?
4. Having understood the fact that 15% or 25% is appropriate RPT filter (depending on the availability of comparables) one needs to know analyze what all items will form part of the numerator and denominator in arriving at the RPT percentage. This is very important in a case where a company has entered into purchase and sale transaction with related party, the question that arises is whether total of RPT purchase and sales needs to be clubbed and then divided by the total turnover or only RPT purchases needs to be divided by total purchases and similarly RPT sales needs to be divided by total sales.
The above question has been addressed by ITAT Delhi Bench in case of Nokia India (P.) Ltd. [2014] 52 taxmann.com 492 (Delhi – Trib.) wherein it was held as follows:
| ♦ | Transactions which do not impact the profitability, such as loan given or taken or other items finding place in the balance sheet, can have no place either in the numerator or the denominator of this formula. However, any income or expenditure resulting/relating from/to or likely to result/relate from/to such items of assets or liabilities should not be confused with the per se international transactions finding place in the balance sheet of the company calling for exclusion. | |
| ♦ | If, however a related party transaction is of such a nature which does not directly affect or insignificantly affects the profit earned from the bare profit producing activity, then it should not be taken into consideration. To cite an example, the RPT of rent paid by a company which is engaged in the business of trading or manufacturing cannot constitute a part of the numerator, because transaction of rent payment has no direct bearing on the trading or manufacturing activity. | |
| ♦ | The percentage of numerator to denominator can be calculated only when the contents of a part of representing the RPT of a particular nature is seen with reference to the contents of whole of that nature. Both the numerator and denominator should have the same nature of contents. This can be done by segregating transactions of one nature, like, comparing RPT of purchase with the total purchases or RPT of sales with the total amount of sales of the company. In a given case, where the RPTs comprise of purchase, sales, small non operating expenses and service income, one can preferably find out two percentages of RPTs by ignoring the RPT of payment of non operating expense of rent, which does not directly affect the profit earned from trading activity. First percentage of RPT purchases with total purchases and second of RPT sales and service income as one unit with the total of sales and service income again as one unit. The decision as to whether such a company be included in the list of comparables by applying the filter of more than 25 per cent RPT, would depend on the outcome of two such percentages of RPTs. If either of the two breaches the 25 per cent threshold, then the company will cease to be comparable. If however, both the percentages are less than 25 per cent, then the company would be liable for inclusion in the list of comparables. |
Similar view has been expressed by Delhi ITAT in case of AithentTechnologies (P.) Ltd. v. Dy. CIT [2016] 74 taxmann.com 214
Legal views on importance of turnover filter:-
5. It is quite surprising to note that there are divergent views on the importance of turnover filter. The Bombay HC in case of CIT v. Pentair Water India (P.) Ltd [2016] 69 taxmann.com 180/381 ITR 216 concluded that turnover is obviously a relevant factor to be considered for comparability. The Hon’ble Bombay HC relied on the decision of the Hon’ble Delhi HC in the case of CIT v. Agnity India Technologies (P.) Ltd. [2013] 36 taxmann.com 289/219 Taxman 26 wherein it was held that the large and bigger company in the area of development of software cannot be bench marked or equated with the small sized companies
However, ITAT Delhi in case of Tata McGraw Hill Education (P.) Ltd v. Asstt. CIT [2016] 69 taxmann.com 418 (Delhi Trib.) has held that when a Company is functionally comparable, it cannot be rejected from the set of comparables on the ground that the turnover of the Company is less than a crore. The ITAT relied on the Delhi HC judgment in case of Chryscapital Investment Advisors (India) (P.) Ltd. v. Dy. CIT [2015] 56 taxmann.com 417/232 Taxman 20/376 ITR 183 wherein it was held by the lordship that the turnover filter is an inappropriate filter.
Though there are divergent views on whether the turnover filter is an appropriate filter or not, it is quite advisable to apply turnover filter while selecting a comparable considering the fact that a 1000 crore company cannot be compared with a 10 crore company considering the reasoning given in the ICAI TP guidance note.
What should be the appropriate turnover filter?
6. ITAT Bangalore in case of ITO v. Infinera India Ltd [2016] 67 taxmann.com 8/157 ITD 637 (Bang. – Trib.) has held that the turnover criteria is a very important factor in selecting a comparable. The judgement was passed after considering the following points:
| ♦ | Reference was made to Special Bench’s decision in case of Dy. CIT v. Quark Systems (P.) Ltd. [2010] 38 SOT 307 (Chd.), wherein the Special Bench held that it is improper to proceed on the basis of lower limit of 1 crore turnover with no higher limit on turnover, as the same was not a reasonable classification | |
| ♦ | Reference was also made to the decision of the ITAT Bangalore Bench in the case of Genesis Integrating Systems (India) (P.) Ltd. v. Dy. CIT, [IT Appeal No.1231 (Bang) 2010], wherein, the turnover of Rs. 1 crore to Rs. 200 crores was held to be proper. |
Thus, it was held that a turnover criteria of 1 to 200 Crore for an assessee having a turnover of 47 crore is reasonable and accordingly Companies having turnover of more than 200 crore were rejected.
However ITAT Bangalore in the case of ITO v. Maxim India Integrated Security (P.) Ltd. in IT(TP) Appeal No.28 (Bang.) of 2012 held the following:
| ♦ | It is pertinent to note that the CIT(A) has applied turnover slab of Rs.1 crore to Rs.200 crores for excluding these companies, whereas there is an inherent difficulty in applying such a turnover slab of Rs.1 crore to Rs.200 crores because the said classification on the basis of slab of the turnover gives unrealistic results, as an entity having Rs.1 crore turnover can be compared with any entity having Rs.200 crores turnover, but at the same time an entity having Rs.200 crores turnover cannot be compared with an entity having Rs.201 crores turnover. | |
| ♦ | Thus, as it is clear from the above illustration that it gives ambiguous result as two entities having difference of Rs.1 crore cannot be considered as comparable, whereas on the other hand difference of Rs.199 crores can be considered as comparable. Therefore, such classification of comparables on the basis of companies selected on turnover basis is not appropriate and acceptable. | |
| ♦ | The turnover, no doubt, is a relevant factor to be taken into account, but there should be some proper and reasonable parameters to apply the difference of turnover between the assessee and the comparable which may be a multiple in the range of 2 times, 3 times, X times or any other number of times which should be applied to all the comparable companies, instead of taking a slab from Rs.1 crore to Rs.200 crores. |
ITAT Bangalore accordingly held that turnover filter upto 10 times can be applied after both the parties agreed in principle to that. Thus for example if the assessee turnover is Rs.45.85 Crores, the company having turnover upto Rs.458.50 Crores on the higher side and Rs.4.58 Crores at the lower side can be considered in the set of comparables.
Conclusion
7. No doubt turnover and RPT filter plays an important role in selecting a comparable. What should be appropriate turnover and RPT filter will depend on facts of the case. One needs to make this decision in light of various judicial pronouncements.
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