Transfer pricing comparability rules: turnover filter, 15% related party threshold, and no standard deduction under section 92C(2).

Transfer pricing comparability in software development service cases was addressed by applying a turnover filter, related party transactions filter and functional comparability tests. Companies with turnover exceeding Rs. 200 crores were treated as unreliable comparables against a much smaller taxpayer and excluded. The Tribunal also held that related party transactions do not automatically disqualify a comparable, but a 15% threshold applies; companies above that level were excluded, while those below it could be retained. Functionally different companies, and high profits without extraordinary circumstances, did not justify exclusion. The 5% range under section 92C(2) was held to be a tolerance band only, not a standard deduction.

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Issues: (i) Whether companies with turnover exceeding Rs. 200 crores could be excluded as comparables in transfer pricing analysis; (ii) whether the related party transactions filter was to be applied at 0% or 15%, and whether certain comparables were to be excluded or restored, including issues of functional comparability and remand; (iii) whether the assessee was entitled to a standard deduction of 5% under the proviso to section 92C(2).

Issue (i): Whether companies with turnover exceeding Rs. 200 crores could be excluded as comparables in transfer pricing analysis.

Analysis: The assessee had a turnover far below Rs. 200 crores, while several selected comparables had very large turnovers. The Tribunal followed earlier coordinate bench decisions holding that size and scale materially affect comparability, and that companies with turnover beyond the upper threshold of Rs. 200 crores should not be compared with small taxpayers in software development service cases.

Conclusion: The turnover filter of Rs. 200 crores was upheld, and the large-turnover companies were rightly excluded as comparables.

Issue (ii): Whether the related party transactions filter was to be applied at 0% or 15%, and whether certain comparables were to be excluded or restored, including issues of functional comparability and remand.

Analysis: The Tribunal held that the presence of some related party transactions does not automatically disqualify a comparable, and that the appropriate threshold is 15% of total revenue. On that basis, the exclusion of companies merely because they had some related party transactions was reversed. Companies with RPT below 15% were directed to be retained. Four Soft Ltd. was excluded because its RPT exceeded 15%. Exensys Software Solutions Ltd. was held to be functionally different and therefore excluded. The challenge concerning Thirdware Solutions Ltd. on the ground of high profits was rejected, because high profit alone is not a valid basis for exclusion without evidence of extraordinary circumstances. Tata Elxsi Ltd. was held to be functionally different from a pure software development service provider and was directed to be excluded. The objections regarding Sankhya Infotech Ltd. were not finally adjudicated on merits and were remanded to the Transfer Pricing Officer for fresh examination. The challenge to inclusion of Visualsoft Technologies Ltd. was dismissed as not maintainable.

Conclusion: The 0% related party transactions filter was rejected, the 15% filter was applied, some comparables were restored, some were excluded, and certain comparability questions were remanded for fresh consideration.

Issue (iii): Whether the assessee was entitled to a standard deduction of 5% under the proviso to section 92C(2).

Analysis: The Tribunal relied on the retrospective amendment brought in by section 92C(2A) to hold that the 5% range is only a tolerance band for determining the arm's length price and does not confer an option of standard deduction. The earlier view adopted by the first appellate authority was therefore not sustainable.

Conclusion: The claim for a 5% standard deduction was rejected.

Final Conclusion: The transfer pricing dispute was decided partly in favour of the Revenue, with the turnover-based exclusion and rejection of the 5% standard deduction sustained, the related party transactions threshold fixed at 15%, and certain comparables either restored, excluded, or remanded for fresh examination.

Ratio Decidendi: In transfer pricing comparability, large scale disparity and materially significant related party transactions affect reliability of comparables, and the statutory tolerance band under section 92C does not operate as a standard deduction.

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