Transfer pricing comparability turns on turnover and functional similarity for captive software development service providers.

In transfer pricing for a captive software development service provider, comparables with materially higher turnover were treated as unsuitable because turnover is a relevant filter in determining arm's length price. The Tribunal also excluded companies with functionally different activities, including product development, software products, research and development, knowledge process outsourcing, and diversified services, especially where no reliable segmental data was available. Since those entities were not functionally comparable to low-risk contract software development services, they were removed from the comparable set and the assessee's appeal succeeded in part.

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Issues: (i) Whether comparables having very high turnover were liable to be excluded while determining the arm's length price of the assessee's software development services segment; (ii) Whether companies found to be functionally dissimilar, including those rendering product development, R&D, KPO or diversified services, were liable to be excluded from the comparable set.

Issue (i): Whether comparables having very high turnover were liable to be excluded while determining the arm's length price of the assessee's software development services segment.

Analysis: The assessee was a captive software development service provider and the dispute was confined to comparability. The Tribunal followed its earlier view that turnover is a relevant filter in transfer pricing analysis and that companies with turnover far exceeding the assessee's scale do not form an apt comparable set. The high-turnover entities selected by the TPO were therefore found unsuitable for comparison.

Conclusion: The comparables rejected on the turnover criterion were directed to be excluded, in favour of the assessee.

Issue (ii): Whether companies found to be functionally dissimilar, including those rendering product development, R&D, KPO or diversified services, were liable to be excluded from the comparable set.

Analysis: The Tribunal examined the functional profile of the contested companies and noted that several of them were engaged in product development, software products, research and development, knowledge process outsourcing, or other diversified activities, with no reliable segmental data to isolate software development services. Since the assessee rendered low-risk contract software development services, such entities were not functionally comparable for arm's length analysis.

Conclusion: The functionally dissimilar comparables were directed to be excluded, in favour of the assessee.

Final Conclusion: The transfer pricing exercise was narrowed by excluding the impugned comparables on turnover and functional grounds, and the assessee's appeal succeeded in part.

Ratio Decidendi: In transfer pricing comparability, companies with materially higher turnover or materially different functions, especially where segmental data is unavailable, cannot be treated as reliable comparables for a captive software development service provider.

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