Transfer pricing comparables and expense characterisation: related-party filters upheld, reimbursements excluded, software capitalised, deposit write-off allowed

Transfer pricing adjustments concerned exclusion of comparables with related party transactions exceeding 15% of turnover; those comparables were to be removed after verification (one comparable at 19.98% excluded). Reimbursements of travel and related costs were held to be pure cost reimbursements not payments for services and therefore excluded from adjustment under section 92CA, decided for the taxpayer. Purchase of computer software was characterised as capital expenditure forming part of profit-making apparatus; AO rightly treated it as capital and depreciation was appropriate, decided against the taxpayer. Write-off of unrecoverable rental deposit was held deductible as a loss incidental to business, decided for the taxpayer.

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Issues: (i) Whether the TPO/DRP's transfer pricing adjustment based on comparables selected by the TPO (including application of turnover filter, functional comparability, related party transaction threshold and working capital adjustments) is sustainable; (ii) Whether reimbursements of expenses received from Associated Enterprises should be included in the operating cost/revenue for ALP determination; (iii) Whether expenditure on purchase of computer software is capital in nature and disallowable as revenue expenditure; (iv) Whether write-off of rental deposit is deductible as a business loss.

Issue (i): Whether the comparables selected by the TPO can be retained and the TPO/DRP's ALP adjustment sustained, having regard to turnover filters, functional dissimilarity, related party transactions and required adjustments (including segmental margin and working capital adjustment).

Analysis: The Tribunal examined prior coordinate-bench decisions dealing with software development comparability and Dun & Bradstreet based turnover ranges. It accepted exclusion of comparables with turnover substantially above the assessee (applying a turnover filter consistent with earlier decisions), directed exclusion of specified functionally dissimilar comparables identified by precedent, required exclusion of comparables with related party transactions exceeding 15% after verification, and directed that the segmental margin of Megasoft be used instead of entity-level margin; it further directed the AO/TPO to compute ALP applying these directions and to make adjustment only if the assessee's margin falls outside the +/-5% bandwidth in proviso to section 92C(2).

Conclusion: The Tribunal upheld in part and modified the TPO/DRP selections: certain high-turnover and functionally dissimilar comparables are to be excluded, RPT >15% comparables are to be excluded after verification, segmental margin for Megasoft is to be used, and ALP is to be reworked by the AO/TPO in accordance with these directions. This results in partial acceptance of the assessee's contentions on comparability.

Issue (ii): Whether reimbursements of expenses received from Associated Enterprises should be added to operating revenues/costs for determining ALP under TNMM.

Analysis: The Tribunal found the documentary details of reimbursements unclear on record and observed that pure pass-through cost recoveries without mark-up should not be added to the cost base. In view of the lack of specific breakup/clarity, the Tribunal remitted the matter to the Assessing Officer/TPO for detailed verification of the nature of the receipts and directed that pure cost recoveries without any service/mark-up should not be added back.

Conclusion: The issue of reimbursements is remitted to the AO/TPO for verification; ground on reimbursements is allowed for statistical purposes (i.e., remand for factual determination in favour of correct treatment based on verification).

Issue (iii): Whether expenditure on purchase of computer software is capital in nature and therefore not allowable as revenue deduction.

Analysis: On the facts and documents, the Tribunal accepted that the software purchased constituted an enduring benefit forming part of the profit-making apparatus and that depreciation had been allowed; the assessee did not produce evidence to rebut the revenue view that the expenditure was capital in nature.

Conclusion: The Tribunal upheld the authorities' treatment and held the expenditure to be capital in nature; the assessee's claim for revenue deduction is rejected.

Issue (iv): Whether the write-off of rental deposit (refundable deposit written off after failure to recover) is an allowable deduction as a business loss incidental to trade.

Analysis: Relying on precedent where similar deposit write-offs were held to be losses incidental to business, the Tribunal considered that the deposit did not result in acquisition of a capital asset or enduring capital benefit and that the write-off arose in the course of carrying on business.

Conclusion: The Tribunal allowed the claim and held the write-off of the rental deposit to be an allowable revenue deduction.

Final Conclusion: The appeal is partly allowed: the Tribunal directed exclusion of specified comparables (turnover and functional grounds), exclusion of comparables with RPT>15% after verification, use of segmental margin for Megasoft, remand of the reimbursement issue to the AO/TPO for factual verification, upheld the capital nature of computer software purchase (claim denied), and allowed the rental deposit write-off as a business deduction.

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