Transfer pricing comparables must match captive software services, with actual working capital adjustment and evidence-based remand issues

Functional comparability in transfer pricing must be tested against a captive, low-risk software development service provider, so companies with diversified operations, product development, significant intangibles, extraordinary events, absent segmental data, or failed filters were excluded from the comparables set. Working capital adjustment is to be computed on actual differences and allowed on verifiable data. Interest on external commercial borrowings must be benchmarked under the applicable foreign currency loan framework. Recharacterisation of marketing support services as a commission agency model requires proper examination of contractual functions and evidence, and may be remanded for fresh verification. Depreciation was allowed on free of cost assets once capitalised and brought into computation, while seconded employee costs, bonding and debonding charges, and tax credits or deductions were sent back for factual verification.

---

---

Issues: (i) exclusion and inclusion of comparables in the software development services segment under the transfer pricing exercise; (ii) allowance of working capital adjustment; (iii) benchmarking of interest on external commercial borrowings; (iv) recharacterisation of marketing support services as a commission agency model; (v) depreciation on free of cost assets received from the associated enterprise; (vi) disallowance relating to salaries and reimbursements for seconded employees and bonding and debonding charges; and (vii) grant of tax credits and deductions, including Chapter VI-A claim, self-assessment tax, advance tax and dividend distribution tax credit.

Issue (i): exclusion and inclusion of comparables in the software development services segment under the transfer pricing exercise.

Analysis: The assessee was a captive, low-risk service provider. Comparables with diversified functions, product development, significant intangibles, extraordinary events, absence of reliable segmental data, or failure to satisfy the relevant filters were found unsuitable for benchmarking. The Tribunal also took note of prior co-ordinate bench decisions on materially similar comparables and applied the turnover and functional comparability principles consistently. Aspire Systems was additionally tested on related party transactions and Nihilent and Infobeans suffered from lack of segmental data.

Conclusion: Persistent Systems Ltd., Larsen & Toubro Infotech Ltd., Thirdware Solutions Ltd. and Infosys Ltd. were directed to be excluded, and Nihilent Ltd., Infobeans Technologies Ltd. and Aspire Systems (India) Pvt. Ltd. were also directed to be excluded from the final set of comparables. The issue was decided in favour of the assessee.

Issue (ii): allowance of working capital adjustment.

Analysis: The transfer pricing margin was to be computed on actual working capital differences between the assessee and the selected comparables. The Revenue authorities had not granted the adjustment on the facts placed before the Tribunal.

Conclusion: The assessee was held entitled to working capital adjustment on actuals, and the matter was restored for computation accordingly in favour of the assessee.

Issue (iii): benchmarking of interest on external commercial borrowings.

Analysis: The interest rate charged on the ECB was examined in the light of the regulatory framework and the Tribunal's settled approach on such cross-border borrowings. A fresh benchmarking contrary to the principles applicable to foreign currency loans was not approved.

Conclusion: The adjustment on ECB interest was not sustained and the matter was decided in favour of the assessee for statistical purposes.

Issue (iv): recharacterisation of marketing support services as a commission agency model.

Analysis: The recharacterisation was made without a proper appreciation of the contractual functions actually performed by the assessee. The issue required de novo verification with due opportunity to place supporting material.

Conclusion: The recharacterisation was set aside for fresh consideration and the issue was remanded in favour of the assessee for statistical purposes.

Issue (v): depreciation on free of cost assets received from the associated enterprise.

Analysis: Where the assets had been capitalised in the accounts and brought into the tax computation as capital assets, depreciation could not be denied merely because the assets had been received free of cost.

Conclusion: The assessee was held entitled to depreciation in accordance with law, and the issue was partly allowed in favour of the assessee.

Issue (vi): disallowance relating to salaries and reimbursements for seconded employees and bonding and debonding charges.

Analysis: The Revenue authorities had not properly examined the evidences relating to deduction of tax, salary reimbursement mechanics, and the alternate claim for depreciation on capital expenditure treated as bonding and debonding charges. Both matters required verification on the record.

Conclusion: These issues were remitted to the Assessing Officer for fresh examination in accordance with law and were decided in favour of the assessee for statistical purposes.

Issue (vii): grant of tax credits and deductions, including Chapter VI-A claim, self-assessment tax, advance tax and dividend distribution tax credit.

Analysis: The assessee's claims were to be verified against the evidence filed and given effect as per law in the computation process.

Conclusion: The matters were sent back for verification and were decided in favour of the assessee for statistical purposes.

Final Conclusion: The transfer pricing additions were substantially curtailed, certain corporate-tax disallowances were remanded or modified, and the appeal succeeded in part.

Ratio Decidendi: In transfer pricing benchmarking, comparables must be functionally similar to a captive service provider and should be excluded where they have significant intangibles, product-led or diversified operations, unreliable segmental data, or fail relevant filters; working capital and other adjustments must be determined on actual and verifiable data.

---