Transfer Pricing Comparable Loss Rule 2025-26: Karnataka HC Ruling

What Happened?

In October 2026, the Karnataka High Court delivered an important judgment on transfer pricing (TP) comparables. The court ruled that Neeman Medical must be retained as a comparable despite reporting losses in one financial year, because it was not consistently loss-making and functional comparability was undisputed. This judgment directly impacts how the Income Tax Department and taxpayers select comparables under Section 92A of the Income Tax Act 2025.

The ruling clarifies a critical point: temporary losses in a single year cannot be grounds to exclude an otherwise suitable comparable from your transfer pricing analysis.

Background & Legal Context

What is Transfer Pricing?
Transfer pricing (TP) is the pricing of transactions between related parties (like parent and subsidiary companies). Under Section 92A of the Income Tax Act 2025, Indian companies must ensure their international transactions are priced at "arm's length"—meaning prices that independent parties would charge.

What Are TP Comparables?
To prove your pricing is arm's length, you need to compare your business with similar independent companies (comparables). These comparables should have:

• Similar functions and risks (functional comparability)
• Similar economic circumstances
• Similar contractual terms
• Healthy financial profile (traditionally assumed to mean profitability)

The Section 92A Framework (IT Act 2025):
Section 92A requires that comparables selected must be "comparable" in substance. The Transfer Pricing Officer (TPO) has discretion to accept or reject comparables. However, this discretion must be exercised rationally and based on proper criteria—not arbitrary grounds like a single-year loss.

What This Ruling Changes:
Previously, some TPOs rejected comparables merely because they showed losses in the year of comparison. The Karnataka HC has now held that this practice is legally incorrect. A single year of loss does not disqualify a comparable if:

• The company is functionally comparable
• The loss is temporary (not a pattern)
• The company remains operationally viable

What Does This Mean for You?

If You Are a Taxpayer (AY 2025-26 and onwards):

• Stronger Defense for Your Comparables: If a TPO rejects your selected comparable merely because it reported a loss in one year, you now have direct judicial backing from Karnataka HC to resist this rejection. This is particularly helpful for AY 2025-26 assessments where loss-making comparables may have been excluded.
• Better Transfer Pricing Positions: Companies in sunrise sectors (pharma, IT, biotech) or those affected by temporary market downturns can now confidently include otherwise suitable comparables. For example, a software company that made a loss in FY 2024-25 due to one-time restructuring costs cannot be automatically excluded as a comparable.
• Reduced Adjustment Risk: TPOs are less likely to make arbitrary transfer pricing adjustments by simply excluding your best comparables. This means lower chances of having your assessed income increased due to TP issues.
• Appeal Success Rate Improves: If your case is under ITAT appeal or HC jurisdiction, this judgment significantly strengthens your position. You can directly cite this ruling to argue that the TPO acted arbitrarily.

If You Are the Income Tax Department:

• TPOs must now apply rational criteria beyond just profitability when rejecting comparables.
• Every rejection of a comparable must be documented with specific reasons—not blanket statements like "loss-making company cannot be comparable."
• The focus must shift to functional and economic comparability, not financial health in a single year.

If You Are in a Related Jurisdiction (outside Karnataka):

While this is a Karnataka HC judgment, it is persuasive authority for ITAT benches in other states and will likely influence future HC judgments. ITAT benches may follow this logic even in non-Karnataka cases. However, always cite this judgment when arguing similar cases in your jurisdiction.

What Should You Do Now?

Immediate Steps (For Ongoing Assessments - AY 2025-26):

• Review Your TP Study: If your comparables were rejected during assessment merely for being loss-making in one year, gather documentation of the rejection and prepare an appeal citing this Karnataka HC judgment.
• Strengthen Your Documentation: If you are selecting comparables for FY 2024-25 (AY 2025-26), document why each comparable is functionally comparable, regardless of temporary losses. Keep 3-year financial data to show the loss was not a pattern.
• Prepare Your Defense: If a TPO is currently objecting to your comparables, immediately file a response stating:
  • The comparable is functionally and economically similar (cite specific similarities)
  • A single-year loss does not disqualify it (cite Karnataka HC judgment)
  • The company remains operationally viable
• File Appeals Promptly: If your assessment is already completed with TP adjustments, file an appeal to ITAT within the statutory time limit (typically 60 days from the assessment order). This judgment substantially strengthens your case.

For Future Compliance (AY 2026-27 onwards):

• Robust Comparable Analysis: Your chartered accountant or transfer pricing consultant should build an analysis that shows functional similarity first, then financial metrics. This reversal of emphasis now has legal backing.
• Document Business Rationale: Maintain detailed notes explaining why each comparable was selected, focusing on business operations, functions, and risks—not just profitability metrics.
• Update Your TP Policy: Ensure your transfer pricing documentation clearly states your criteria for selecting comparables and explicitly mentions that temporary losses do not disqualify functionally comparable entities.

Key Takeaways

• Landmark Ruling on TP Comparables: Karnataka HC has ruled that single-year losses cannot justify exclusion of transfer pricing comparables if functional comparability is established (October 2026).
• Applies to Section 92A (IT Act 2025): This judgment directly interprets Section 92A, making it binding precedent for all Karnataka-based taxpayers and persuasive for others.
• Strengthens Taxpayer Position for AY 2025-26: Businesses can now defend their TP studies against arbitrary rejection of comparables. This is especially valuable for cyclical industries and pandemic-affected sectors.
• Burden on TPO to Justify: The judgment shifts the onus—TPOs must now provide rational, documented reasons for rejecting a comparable beyond just citing losses in one year.
• Wide Applicability: While Karnataka HC judgment, it will influence ITAT decisions nationwide and is expected to become standard practice across all jurisdictions by AY 2026-27.

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