Appeal allowed, directions for recalculating arm's length price, excluding disputed comparables, treating forex fluctuation as operating item.

The appeal was allowed with directions for the Assessing Officer (AO) and Transfer Pricing Officer (TPO) to recalculate the arm's length price of the international transaction. The rejection of the Transfer Pricing Study and the inclusion of certain companies as comparables were contested. The AO/TPO were directed to exclude the disputed comparables and treat foreign exchange fluctuation as an operating item. Penalty proceedings were criticized for being mechanically initiated without adequate satisfaction.

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Issues Involved:
1. Transfer pricing addition.
2. Reference to Transfer Pricing Officer (TPO).
3. Rejection of Transfer Pricing Study.
4. Application of filters by TPO.
5. Selection of comparable companies.
6. Risk adjustment.
7. Penalty proceedings under Section 271(l)(c).

Detailed Analysis:

1. Transfer Pricing Addition:
The Assessing Officer (AO) assessed the total income of the appellant at Rs. 19,14,56,510/- against the returned income of Rs. 9,90,640/- after making a transfer pricing addition of Rs. 19,04,65,871/- for software development and maintenance services rendered to its parent company, Fiserv Global Services Inc., USA.

2. Reference to TPO:
The AO referred the international transaction to the TPO without recording reasons for considering it necessary or expedient, which was challenged by the appellant.

3. Rejection of Transfer Pricing Study:
The AO and Dispute Resolution Panel (DRP) erred in confirming the TPO's action in rejecting the appellant's Transfer Pricing Study and conducting a fresh benchmarking analysis based on conjectures and surmises.

4. Application of Filters by TPO:
The AO and DRP confirmed the TPO's application of various filters, including:
- Use of only current year data.
- Rejecting companies with different financial years.
- Rejecting companies with turnover below Rs. 1 crore without an upper filter.
- Rejecting companies with export revenues less than 75% of operating revenues.
- Rejecting companies with related party transactions exceeding 25%.
- Rejecting companies with employee costs less than 25% of total operating costs.
- Rejecting companies with diminishing revenue/persistent losses.

5. Selection of Comparable Companies:
The appellant contested the inclusion of certain companies as comparables:
- Bodhtree Consulting Ltd.: Excluded due to abnormally high increasing sales/profitability and functional differences.
- Infosys Ltd.: Excluded due to its giant stature, brand value, and significant intangibles, making it incomparable with the appellant.
- Thirdware Solutions: Excluded due to functional differences, product/license sales, and significant related party transactions.
- Sonata Software: Excluded due to product sales, significant related party transactions, and extraordinary events like setting up a subsidiary in Dubai.
- Mindtree Ltd.: Remanded to TPO for reconsideration due to extraordinary events like acquisition and amalgamation.
- Kals Information Systems: Excluded due to functional differences and involvement in product development.

6. Risk Adjustment:
The AO and DRP erred in not allowing the risk adjustment claimed by the appellant under Rule 10B(1)(e) read with Rule 10B(3) of the Income Tax Rules, 1962.

7. Penalty Proceedings under Section 271(l)(c):
The AO/TPO erred in mechanically initiating penalty proceedings without recording adequate satisfaction for such initiation.

Treatment of Foreign Exchange Fluctuation:
The foreign exchange fluctuation gain/loss is to be treated as an operating item, as it is an integral part of the sale proceeds for companies engaged in export business.

Conclusion:
The appeal is allowed with directions to the AO/TPO to recompute the arm's length price of the international transaction, excluding the contested comparables and treating foreign exchange fluctuation as an operating item.

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