Software company comparables in transfer pricing ALP dispute-three supernormal-profit firms excluded, leaving no adjustment within s.92C(2) tolerance.

Transfer pricing comparables for determining ALP were in dispute, specifically the inclusion of three software companies alleged to be supernormal profit earners and, in one case, having significant related party transactions. The Tribunal held that the TPO failed to deal with objections with reasons, ignored material showing related party transactions, and relied on superficial grounds (listed status/audit) despite undisputed supernormal margins; accordingly, all three companies were directed to be excluded from the comparable set. Upon recomputation using TPO data after exclusion, the arithmetic mean OP/OC became 17.15%, falling within the ±5% tolerance under s.92C(2), resulting in no transfer pricing adjustment and relief to the assessee. The DRP's cursory order was held contrary to s.144C.

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Issues: Whether the upward transfer-pricing adjustment of Rs. 10,40,75,727/- made by the Transfer Pricing Officer/Assessing Officer and sustained by the DRP by including three alleged supernormal-profit comparables (Cranes Software International Ltd., GDA Technologies Ltd., Jayamaruthi Software Systems Ltd.) was justified; and whether those comparables should be excluded leading to a reduction of the adjustment within the tolerance prescribed by section 92C(2).

Analysis: The issue was examined by assessing (i) the functional comparability and profitability profile of the three challenged companies and (ii) the adequacy of the departmental response to the assessee's detailed submissions before the DRP under section 144C. The challenged companies displayed markedly higher operating-profit/operating-cost margins compared with the rest of the comparable set and had characteristics (product/INTANGIBLE-heavy business or atypical cost structures and absent segmental/validated information) that materially differentiate their functions and risks from the assessee's routine contract software services. The departmental order did not record cogent reasons addressing the specific objections on functional differences and supernormal profitability, and the DRP's order did not adequately consider the voluminous submissions filed by the assessee as required under section 144C. Recomputing the mean OP/OC after excluding the three companies using the departmental data yields an arithmetic mean of 17.15%, which falls within the +/-5% range permitted by section 92C(2).

Conclusion: The inclusion of the three identified comparables was not justified; upon their exclusion and recalculation the transfer-pricing adjustment is not warranted and the addition is set aside in favour of the assessee.

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