The Income Tax Appellate Tribunal, Bangalore, has delivered a significant ruling clarifying key principles in transfer pricing analysis, particularly regarding the application of the Related Party Transaction (RPT) filter, working capital adjustments, and interest computation on foreign currency receivables. The judgment reinforces that mechanistic application of search matrices is impermissible and mandates a functional, data-driven approach to comparability analysis under Rule 10B of the Income-tax Rules.
Background & Facts
The Dispute
The appellant, DRG Analytics and Insights Pvt. Ltd., a private limited company providing back-office support services (BSS) to its associated enterprises (AEs), faced transfer pricing adjustments for Assessment Year 2020-21. The Total Turnover from international transactions amounted to Rs. 1,16,34,42,195. The assessee adopted the Transactional Net Margin Method (TNMM) with Profit Level Indicator (PLI) as Operating Profit over Operating Cost (OP/OC), arriving at a margin of 16.63%. The Transfer Pricing Officer (TPO) rejected nine of the eleven comparables selected by the assessee and introduced additional comparables, including Liquidhub Analytics Pvt. Ltd., resulting in an upward adjustment of Rs. 2,88,03,369.
Key Facts
- The assessee initially selected 11 comparables for its TP study report.
- The TPO accepted only two comparables: Allsec Technologies Limited and Sundaram Business Services Limited.
- The TPO added 10 new comparables, including Liquidhub Analytics Pvt. Ltd., bringing the final list to 12.
- Liquidhub Analytics Pvt. Ltd. had a Related Party Transaction (RPT) ratio of 31.80% based on related party income (Rs. 42,99,80,000) as a percentage of total income (Rs. 1,35,23,40,000).
- The TPO applied a 25% RPT filter, which Liquidhub failed.
- The assessee proposed three additional comparables: Jindal Intellicom Limited, Riddhi Corporate Services Limited, and Digicall Global Private Limited, which were excluded for not being in the TPO’s search matrix.
- The TPO included Rs. 6,05,44,154 as ESOP reimbursement cost in the assessee’s operating cost without corresponding revenue recognition.
- The TPO computed notional interest of Rs. 2,57,45,073 on delayed trade receivables using SBI PLR (13.27%), despite invoices being in foreign currency.
- The assessee claimed working capital adjustment due to differences in receivables, payables, and inventory but failed to provide average balance data.
Procedural History
- 06.06.2024: Order u/s 143(3) r.w.s. 144C(13) passed by TPO making transfer pricing adjustments.
- Before DRP: Assessee filed objections; DRP upheld inclusion of Liquidhub, rejection of Jindal/Riddhi/Digicall, inclusion of ESOP cost, and notional interest.
- 12.02.2026: Hearing before ITAT Bangalore.
- 29.04.2026: Judgment pronounced.
The Parties' Positions
For the Assessee
- Liquidhub Analytics failed the 25% RPT filter and must be excluded.
- Jindal, Riddhi, and Digicall are functionally comparable and should be included despite not being in the TPO’s search matrix.
- ESOP cost was borne by the AE; including it only in cost base without corresponding revenue distorts the cost-plus model.
- Interest on receivables should be computed using LIBOR+200 bps, not SBI PLR, as invoices are in foreign currency.
- Working capital adjustment must be granted based on average balances and material differences.
For the Revenue
- Liquidhub’s RPT ratio was correctly computed as under 25% by considering only related party revenue as a percentage of total revenue.
- Inclusion of comparables outside the TPO’s search matrix amounts to cherry-picking.
- ESOP cost is attributable to services rendered by assessee’s employees and must form part of operating cost.
- SBI PLR is appropriate for interest computation.
- Working capital adjustment cannot be granted without reliable data on average balances and cost of funds.
Relief Sought
The assessee sought:
- Exclusion of Liquidhub Analytics from comparables.
- Inclusion of Jindal, Riddhi, and Digicall as comparables.
- Exclusion of ESOP cost from operating cost or inclusion of corresponding reimbursement as revenue.
- Recomputation of interest on receivables using LIBOR+200 bps.
- Grant of working capital adjustment based on average balances.
The Legal Issue
The central questions were: (1) Whether a comparable can be excluded from transfer pricing analysis solely on failure to meet a 25% RPT filter when the filter is applied uniformly; (2) Whether comparables not in the TPO’s search matrix can be included if functionally comparable; (3) Whether ESOP reimbursement cost must be matched with corresponding revenue under the cost-plus model; (4) Whether interest on foreign currency trade receivables must be computed using LIBOR-based rates; and (5) Whether working capital adjustment requires computation based on average balances under Rule 10B.
Arguments Presented
For the Appellant/Petitioner
The assessee relied on Dotgo (P.) Ltd. v. DCIT, IG Infotech (P.) Ltd. v. ACIT, and Quicklogic Software (P.) Ltd. v. DCIT to argue that functional comparability under FAR analysis is paramount and search matrices are merely tools. It contended that excluding Liquidhub was mandatory under the TPO’s own 25% RPT filter. For ESOP, it cited the principle of parity under cost-plus model. For interest, it relied on Synechron Technologies (P.) Ltd. v. ACIT to argue for LIBOR+200 bps. For working capital, it cited Mentor Graphics (Noida) Pvt. Ltd. and Agilent Technologies (International) P. Ltd. to argue that differences in receivables and payables necessitate adjustment.
For the Respondent/State
The Revenue relied on Supportsoft India Pvt. Ltd., Cisco Systems (India) Pvt. Ltd., and SAP India (P.) Ltd. to argue that RPT filter must be upheld and that inclusion of comparables outside the search matrix constitutes cherry-picking. It contended that ESOP cost is attributable to services rendered and must be included in cost base. It argued that SBI PLR is a reasonable proxy for interest and that working capital adjustment requires detailed data on average balances and cost of funds, which the assessee failed to provide.
The Court's Analysis
"Once the TPO has chosen to apply a 25% RPT filter, the same has to be applied uniformly to all comparables. A company having related party transactions beyond such threshold cannot be regarded as an uncontrolled comparable."
The Tribunal held that the TPO’s 25% RPT filter, once adopted, must be applied consistently. Liquidhub’s RPT ratio of 31.80% exceeded this threshold, and judicial precedents cited by the Revenue did not address the computation methodology. Hence, Liquidhub was excluded.
"The search matrix is a guiding tool and provides a structured starting point, but it is not conclusive. Functional comparability under FAR analysis is the primary test for inclusion or exclusion."
The Tribunal rejected the mechanical exclusion of Jindal, Riddhi, and Digicall solely on non-inclusion in the search matrix. It held that rejection without FAR analysis constitutes cherry-picking by the TPO. The assessee must demonstrate functional similarity and explain why the comparables were not in the search matrix.
"If a particular expenditure is considered as part of operating cost for the purpose of transfer pricing analysis, the corresponding reimbursement must also be considered as part of operating revenue."
The Tribunal found the TPO’s one-sided adjustment of ESOP cost - adding it to cost base without recognizing reimbursement as revenue - distorted the cost-plus model. Parity between cost and revenue was mandated.
"Where the underlying transaction is in foreign currency, the appropriate benchmark rate is LIBOR plus a reasonable basis point spread."
The Tribunal held that SBI PLR was inappropriate for foreign currency receivables. It adopted the Synechron precedent and directed use of LIBOR plus 200 basis points.
"Working capital differences directly impact profitability and therefore must be examined. The burden shifts to the TPO to demonstrate that such differences do not materially affect the margins."
The Tribunal directed the AO to compute working capital adjustment using average balances of receivables, payables, and inventory, applying the SBI Prime Lending Rate as on 30th June. It clarified that working capital adjustment and interest on delayed receivables are distinct: the former is based on year-end balances, the latter on transaction-specific delays.
The Verdict
The appeal was partly allowed. The Tribunal:
- Excluded Liquidhub Analytics Pvt. Ltd. from comparables due to RPT ratio exceeding 25%.
- Directed the AO to re-examine Jindal, Riddhi, and Digicall on functional comparability grounds, not search matrix exclusion.
- Directed the AO to include the ESOP reimbursement amount (Rs. 6,05,44,154) as operating revenue to match the cost adjustment.
- Directed recomputation of interest on trade receivables at LIBOR plus 200 basis points, for actual delay beyond agreed credit period.
- Directed the AO to compute working capital adjustment using average balances of receivables, payables, and inventory, applying SBI Prime Lending Rate as on 30.06.2020, and adjust comparables’ margins accordingly.
- Directed the AO to recompute interest under sections 234A, 234B, and 234C in light of the above.
What This Means For Similar Cases
Functional Comparability Overrides Search Matrix Exclusion
- Practitioners must challenge exclusion of comparables based solely on search matrix absence.
- File detailed FAR analysis (Functions, Assets, Risks) for any proposed comparable, even if not in TPO’s list.
- Argue that mechanical rejection without FAR analysis violates Rule 10B and amounts to cherry-picking by the TPO.
RPT Filter Must Be Applied Consistently and Transparently
- Always verify how RPT ratio is computed: related party revenue as % of total revenue, not total income.
- If a comparable exceeds the TPO’s stated RPT threshold, demand its exclusion.
- Challenge inconsistent application of filters across comparables.
ESOP and Reimbursement Costs Require Dual Recognition
- In cost-plus model, any cost borne by AE but attributed to assessee must be matched with corresponding revenue.
- Argue that one-sided adjustments violate the arm’s length principle.
- Maintain clear documentation of reimbursement flows and accounting treatment.
Working Capital Adjustment Requires Average Balance Data
- Do not rely on balance sheet figures alone; compute average opening and closing balances.
- Use revenue account items only (trade receivables, payables, inventory).
- Apply interest rate as on 30th June of the relevant year.
- Shift burden to TPO: if differences exist, require them to prove lack of material impact.
Interest on Foreign Currency Receivables Must Use LIBOR-Based Rates
- Always object to use of domestic rates (SBI PLR) for foreign currency transactions.
- Cite Synechron Technologies to support LIBOR+200 bps as reasonable.
- Compute interest only on actual delay beyond agreed credit period.
