Tribunal directs exclusion of comparables & 0.85% risk adjustment, orders recalculation

The Tribunal partially allowed the appeal by directing the exclusion of specific comparables and the allowance of a risk adjustment of 0.85%. The Transfer Pricing Officer was instructed to recalculate the arm's length price accordingly.

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Issues Involved:
1. Selection of Comparables
2. Risk Adjustment

Detailed Analysis:

1. Selection of Comparables:
The primary issue revolves around the selection of comparable companies for determining the arm's length price (ALP) for the assessee, a captive service provider to its Associated Enterprise (AE). The Transfer Pricing Officer (TPO) selected 17 comparables, which included companies that the assessee objected to on grounds of functional dissimilarity and other factors.

Objections to Specific Comparables:

- Bodhtree Consulting Ltd.:
- Related Party Transactions Filter: The company had significant transactions with related parties, which should disqualify it as a comparable.
- Functionally Different Filter: The company provides e-paper solutions and data cleansing software, categorizing it under IT-enabled services rather than pure software development.

- Exensys Software Solutions Ltd.:
- Functionally Different: The company is involved in software products and ITES, owning significant brand intangibles.
- Exceptional Year of Operations: The amalgamation with Holool India Ltd. had a material impact on its financial results.
- Error in Margin Computation: Deferred revenue expenditure was excluded in margin computation.

- Sankhya Infotech Ltd.:
- Functionally Different: The company is primarily into software products, as indicated by various disclosures and responses to notices.

- Foursoft Ltd.:
- Functionally Different: The company derives income from software licenses and AMC's, indicating it is not a pure software development service provider.

- Thirdware Solutions Ltd.:
- Functionally Different: The company engages in implementation and customer services for ERP software and is a distributor of products.

- Tata Elxsi Ltd.:
- Specialized Embedded Software Development: The company operates in complex segments, making it incomparable to a software services provider.

- Infosys Technologies Ltd.:
- Diversified Activities: The company's engagement in products, consultancy, and solutions, along with its significant brand value and economies of scale, makes it incomparable to a small captive service provider.

- Flexitronics Ltd.:
- Functionally Different: The company is involved in product development and reported very high margins, making it unsuitable as a comparable.

Tribunal's Findings:
The Tribunal found merit in the assessee's objections, noting that the comparability of these companies had been rejected in previous cases involving similar software development service providers. The Tribunal directed the exclusion of Bodhtree Consulting Ltd., Exensys Software Solutions Ltd., Sankhya Infotech Ltd., Foursoft Ltd., Thirdware Solutions Ltd., Tata Elxsi Ltd., Infosys Technologies Ltd., and Flexitronics Ltd. from the list of comparables.

2. Risk Adjustment:
The assessee sought a risk adjustment to account for differences in risk profiles between itself and the comparables. The TPO computed a risk adjustment of 0.85% but did not allow it in the final analysis.

Tribunal's Findings:
The Tribunal noted that the TPO himself had concluded that a risk adjustment of 0.85% was appropriate. Additionally, in a subsequent assessment year (AY 2007-08), a risk adjustment of 1% had been allowed for the assessee. Consequently, the Tribunal directed the TPO to allow a risk adjustment of 0.85% while computing the ALP.

Conclusion:
The Tribunal partly allowed the appeal, directing the exclusion of specific comparables and the allowance of a risk adjustment of 0.85%. The Assessing Officer/TPO was instructed to recompute the ALP accordingly and make any necessary adjustments.

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