Turnover Filter & Netting of AE Receivables/Payables Mandatory for Transfer Pricing Comparables: ITAT Bangalore

The Income Tax Appellate Tribunal, Bangalore, has delivered a significant ruling clarifying the application of turnover filters in transfer pricing comparability analysis and the necessity of netting receivables and payables with the same associated enterprise. The judgment reinforces that economic scale, not just functional similarity, must inform the selection of comparables and that interest adjustments on delayed trade receivables must account for offsetting payables to reflect true economic substance.

Background & Facts

The Dispute

The appellant, Pathpartner Technology Pvt. Ltd., a private limited company engaged in software development and embedded technology services, was assessed for the Assessment Year 2021-22. The Assessing Officer (AO), acting under directions from the Transfer Pricing Officer (TPO) and the Dispute Resolution Panel (DRP), made two primary adjustments: (1) an upward transfer pricing adjustment of Rs. 5,61,19,488/- by excluding certain comparables and including high-turnover companies in the benchmarking analysis; and (2) an imputation of notional interest of Rs. 93,239/- on delayed trade receivables from associated enterprises (AEs), treating such delays as separate international transactions.

Key Facts

• The assessee’s turnover from software development services (SWD segment) for AY 2021-22 was Rs. 72.39 crores.
• The assessee initially selected 23 comparables for its transfer pricing study using the Transactional Net Margin Method (TNMM), with Profit Level Indicator (PLI) as Operating Profit over Operating Costs at 16.09%.
• The TPO rejected 14 of the assessee’s selected comparables and added 18 new ones, including companies with turnover exceeding Rs. 1,000 crores.
• The TPO’s final list of comparables included: Mindtree Ltd. (Rs. 7,967.80 crores), Larsen & Toubro Infotech (Rs. 11,562.80 crores), Wipro Ltd. (Rs. 50,299.40 crores), Infosys Ltd. (Rs. 85,912.00 crores), and Tata Consultancy Services (Rs. 1,35,963.00 crores).
• The TPO computed an average PLI of 25.09% from these comparables, resulting in an upward adjustment of Rs. 5,61,19,488/-.
• The TPO also treated delayed trade receivables from AEs as unsecured loans and computed notional interest at SBI PLR (12.27%) after a 60-day credit period, resulting in an initial adjustment of Rs. 3,28,481/-. The DRP later reduced this to Rs. 93,239/- by adopting LIBOR + 350 basis points.
• The assessee had not charged interest on delayed receivables from either AEs or third parties.
• The assessee also had outstanding payables to the same AEs, creating a netting position.

Procedural History

• 24.09.2024: DRP issued directions under Section 144C(5) of the Income Tax Act, upholding the TPO’s adjustments.
• 2024: AO passed assessment order under Section 143(3) read with Section 144C(13), incorporating DRP directions.
• 2024: Assessee filed appeal before ITAT Bangalore (IT(TP)A No. 2209/Bang/2024).
• 20.04.2026: Hearing conducted before the Tribunal.
• 29.04.2026: Judgment pronounced.

The Parties' Positions

For the Assessee

• Argued that companies with turnover exceeding 10 times the assessee’s turnover (Rs. 72.39 crores) are not comparable due to economies of scale, market power, and risk profiles.
• Relied on OECD Transfer Pricing Guidelines (para 3.43) and ICAI Guidance Note (para 5.50 and 15.4), which recognize size and turnover as relevant comparability factors.
• Cited Autodesk India (P) Ltd. v. DCIT (2018) and Robert Bosch Engineering v. DCIT (2020) to support exclusion of high-turnover comparables.
• Contended that the Karnataka High Court in CIT v. Yodlee Infotech and Pentair Water India affirmed that turnover is a valid filter.
• Argued that interest on delayed receivables is not a separate international transaction but a consequence of the principal sale transaction.
• Asserted that working capital adjustment already captures the impact of receivables and payables.
• Requested netting of receivables and payables with the same AE to determine true benefit.
• Sought application of LIBOR + 200 basis points for interest computation, citing Synechron Technologies v. ACIT.

For the Revenue

• Contended that turnover is not a statutory criterion under Rule 10B of the Income Tax Rules.
• Argued that functional comparability alone suffices, and size differences do not materially affect profitability in the software industry.
• Relied on DRP’s view that high-turnover companies are functionally comparable.
• Supported the TPO’s use of SBI PLR and later DRP’s LIBOR + 350 basis points.
• Maintained that delayed receivables constitute a separate international transaction under the amended definition of Section 92B.
• Opposed netting of receivables and payables, asserting each transaction must be evaluated independently.

Relief Sought

The assessee sought:

• Exclusion of comparables with turnover exceeding Rs. 200 crores or 10 times its own turnover.
• Disallowance of notional interest on delayed receivables as a separate transaction.
• Application of LIBOR + 200 basis points for interest computation.
• Netting of receivables and payables with the same AE before any interest adjustment.
• Setting aside of the transfer pricing adjustment of Rs. 5,61,19,488/-.

The Legal Issue

The central questions were: (1) Whether turnover can be a valid criterion for excluding comparables in transfer pricing analysis under Section 92C and Rule 10B of the Income Tax Rules, and (2) Whether interest on delayed trade receivables from an associated enterprise must be computed after netting against payables to the same enterprise.

Arguments Presented

For the Appellant

The assessee relied on the OECD Guidelines, ICAI Guidance Notes, and binding precedents from the Bombay High Court (CIT v. Pentair Water India) and ITAT Bangalore (Autodesk India, Robert Bosch) to argue that turnover is a recognized comparability factor. It emphasized that companies with turnover exceeding Rs. 1,000 crores enjoy economies of scale, superior bargaining power, and lower per-unit costs, making their margins non-comparable to a mid-sized firm like the assessee. Regarding interest, the assessee cited Avery Dennison and its affirmation by the Delhi High Court and Supreme Court to argue that netting receivables and payables with the same AE is mandatory to avoid artificial adjustments. It further contended that LIBOR + 200 basis points, as upheld in Synechron Technologies, is the appropriate benchmark rate.

For the Respondent

The Revenue contended that the Income Tax Act and Rules do not prescribe turnover filters and that functional comparability under FAR (Functions, Assets, Risks) is the sole criterion. It argued that software companies operate with low fixed assets and that turnover does not correlate with profitability. It maintained that the amended definition of "international transaction" under Section 92B explicitly includes deferred receivables, making interest imputation mandatory. It opposed netting, asserting that each transaction must be benchmarked independently, and supported the DRP’s use of LIBOR + 350 basis points.

The Court's Analysis

The Tribunal conducted a comprehensive review of statutory provisions, international guidelines, and judicial precedents. It held that while functional comparability is foundational, size and turnover are legitimate factors under the OECD Guidelines and ICAI Guidance Notes. The Tribunal emphasized that economies of scale, market position, and asset base are directly influenced by turnover, and ignoring these differences leads to distorted profit margins.

"The size of the company is a recognized factor for comparability, as differences in turnover and market share influence pricing and margins."

The Tribunal noted that the Karnataka High Court in CIT v. Yodlee Infotech and Pentair Water India had explicitly held that a company with turnover exceeding 200 crores cannot be compared with a company having turnover of less than 100 crores. It further cited Autodesk India and Robert Bosch as binding coordinate bench decisions of the ITAT Bangalore, which had excluded high-turnover comparables.

Regarding the interest adjustment, the Tribunal acknowledged that Section 92B, as amended, includes deferred receivables as international transactions. However, it rejected the TPO’s isolated treatment of receivables. The Tribunal held:

"Where the assessee has both receivables and payables with the same AE, the impact of delay cannot be examined in isolation. If the assessee is also enjoying credit from the same AE, the real benefit, if any, has to be determined on a net basis."

It relied on Avery Dennison (I) (P) Ltd. and its affirmation by the Delhi High Court and Supreme Court to establish that netting is mandatory. The Tribunal clarified that netting is permissible only between the same AE, not across different entities.

On the interest rate, the Tribunal found the DRP’s application of LIBOR + 350 basis points excessive. It adopted the rate of LIBOR + 200 basis points, as consistently upheld in Synechron Technologies, noting that this rate reflects a reasonable spread for service sector receivables.

The Verdict

The appeal was partly allowed. The Tribunal directed the exclusion of the following comparables from the benchmarking set due to excessive turnover: Mindtree Ltd., Larsen & Toubro Infotech, Wipro Ltd., Infosys Ltd., Tata Consultancy Services, and Nihilent Ltd. The adjustment of Rs. 5,61,19,488/- was set aside. Regarding notional interest, the Tribunal directed the TPO to recompute the adjustment by netting receivables and payables with the same AE and applying LIBOR + 200 basis points for the actual period of delay beyond the agreed credit period. The interest adjustment of Rs. 93,239/- was vacated pending recalculation. The TPO was directed to grant the assessee a reasonable opportunity before recomputing the adjustment.

What This Means For Similar Cases

Turnover Filters Are Legally Valid in Transfer Pricing

• Practitioners must now argue for exclusion of comparables with turnover exceeding 5-10 times the tested party’s turnover, especially in service sectors.
• The ICAI Guidance Note and OECD Guidelines provide a solid foundation for such arguments.
• Rely on Autodesk India, Robert Bosch, and Yodlee Infotech as binding precedents in ITAT and High Court jurisdictions.
• Do not accept DRP or TPO arguments that "functional similarity alone suffices" without addressing scale.

Netting of Receivables and Payables Is Mandatory

• Always analyze receivables and payables with the same AE together before applying interest adjustments.
• Submit detailed schedules showing net exposure to each AE, not gross receivables.
• Cite Avery Dennison and its Supreme Court affirmation to resist artificial interest imputations.
• If the net position is payable to the AE, no interest adjustment on receivables should survive.
• LIBOR + 200 basis points is now the preferred benchmark for service sector receivables.

Procedural Compliance Is Non-Negotiable

• Ensure that any recomputation by the TPO is done after providing the assessee a full opportunity to be heard.
• Maintain contemporaneous documentation of credit terms, currency of invoices, and payment patterns.
• Use NASSCOM or Dun & Bradstreet classifications to justify turnover ranges in submissions.