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Benchmarking: Higher Turnover Filter Rejected

In an important ruling in the case of Capgemini India Private Limited (CIPL), the Mumbai Bench of the Tribunal has laid out important principles concerning benchmarking under the Transaction Net Margin Method (TNMM).

Taxand India investigates the case which led to the rejection of the higher turnover filter for software companies.

CIPL had an annual revenue of INR 5 billion in financial year 2006-07. It benchmarked its transactions using TNMM and identified 4 comparable companies including technology giants such as Infosys (annual revenue of 130 billion) and Wipro (annual revenue of 100 billion). The Transfer Pricing Officer (TPO) added 2 more comparables during the audit proceedings and determined the Arms Length Price (ALP), which resulted in a Transfer Pricing adjustment.

After CIPL's objections were rejected by the Dispute Resolution Panel, CIPL contended that the comparability of Infosys and Wipro should be excluded as these companies, with very high turnover, enjoyed economies of scale and had a better bargaining power. They referred to a Dun and Bradstreet survey report which had categorised companies with a turnover of INR 2 to 20 billion separately from companies with a turnover of more than INR 20 billion.

The Revenue submitted before the Tribunal a graphical relationship between the margins and the turnover for the comparables and contended that there was no linear relationship between them. The Revenue further contended that the economies of scale were not relevant for service providers.

The Tribunal ruled that unlike manufacturing companies who employ significant fixed assets, concept of economies of scale was not relevant to service providers. It also held that the Dun and Bradstreet categorisation was only on the basis of turnover and in the absence of empirical evidence that margins earned are related to turnover levels, such categorisation could not be accepted. Accordingly, it rejected the argument that a higher turnover filter should be applied in the case of software companies.

Discover more: Tribunal lays out important principles regarding TNMM benchmarking

Your Taxand contact for further queries is:
Mukesh Butani
T. +91 124 339 5010

Taxand's Take

The Tribunal's conclusion that the concept of economies of scale should not apply to service providers is narrow interpretation of law, keeping in mind broad principles of comparability. Several rulings of the Tribunal in the past have referred to the Dun and Bradstreet survey and held that a higher turnover filter of INR 2 billion be applied in benchmarking taxpayers with turnover at lower levels. While the ruling rejects the application of the higher turnover filter, it is interesting to note that it has applied turnover levels as the basis to separate established companies from the rest and ruled that the 2 categories are not comparable. This is an artificial comparability principle.

Taxand's Take Author

Mukesh Butani
Taxand Board member