Tribunal excludes companies from comparables list based on turnover and functional dissimilarity

The Tribunal partly allowed the assessee's appeal, directing the exclusion of certain companies from the comparables list based on turnover and functional dissimilarity. Companies with high Related Party Transactions were also excluded. The issue of including reimbursement of expenses received from the Associated Enterprise as part of operating costs was remanded for verification.

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Issues Involved:
1. Exclusion of certain comparable companies due to turnover exceeding Rs. 200 crores.
2. Functional dissimilarity of certain comparable companies.
3. Exclusion of companies with Related Party Transactions (RPT) exceeding 15%.
4. Inclusion of reimbursement of expenses received from AE as part of operating cost.

Issue-wise Detailed Analysis:

1. Exclusion of Certain Comparable Companies Due to Turnover Exceeding Rs. 200 Crores:
The Tribunal held that companies with turnover exceeding Rs. 200 crores should not be considered comparable to the assessee, whose turnover is less than Rs. 100 crores. This decision was based on the principle that size significantly impacts comparability. The Tribunal cited the case of Triology E-Business Software India Pvt. Ltd. and other precedents, emphasizing that a reasonable classification of turnover is necessary for comparability. Consequently, the following companies were excluded:
- Flextronics Software Systems Ltd. (Rs. 595.12 crores)
- Infosys Technologies Ltd. (Rs. 9028.00 crores)

2. Functional Dissimilarity of Certain Comparable Companies:
The Tribunal found that certain companies were not functionally comparable to the assessee, which is engaged in pure software development services. The companies excluded for functional dissimilarity were:
- KALS Information Systems Ltd.
- Tata Elxsi Ltd.
- Accel Transmatic Ltd.
These exclusions were based on previous Tribunal decisions, including Tektronix Engineering Development India Pvt. Ltd., which held that these companies were either engaged in software product development or other activities not comparable to pure software development services.

3. Exclusion of Companies with Related Party Transactions (RPT) Exceeding 15%:
The Tribunal excluded companies with RPT exceeding 15%, following the precedent set in Agile Software Enterprises Pvt. Ltd. The excluded companies were:
- Aztec Software Ltd. (17.78% RPT)
- Geometric Software Ltd. (19.34% RPT)
- Megasoft Ltd. (17.08% RPT)
The Tribunal consistently applied the 15% RPT filter to ensure comparability.

4. Inclusion of Reimbursement of Expenses Received from AE as Part of Operating Cost:
The Tribunal addressed the issue of whether the reimbursement of expenses received from the AE should be included in the operating cost. The assessee argued that these reimbursements were out-of-pocket expenses and should not be considered as operating revenue or expenses. The Tribunal referred to the case of L.G. Soft India Pvt. Ltd., which held that such reimbursements should not be added to the cost base for markup purposes. However, the Tribunal remanded the issue to the TPO for verification of the nature of these receipts. If confirmed as reimbursements, they should neither be considered as operating income nor operating expenses for calculating margins.

Conclusion:
The appeal by the assessee was partly allowed. The Tribunal directed the exclusion of certain companies from the comparables list due to turnover and functional dissimilarity and upheld the exclusion of companies with high RPT. The issue of reimbursement of expenses was remanded for verification.

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