Functional comparability governs transfer pricing comparables; a loss-making company cannot be excluded solely for reporting a loss.

Functional comparability, not a single year's profit or loss, governs the selection of comparables in transfer pricing analysis. The Tribunal held that a loss-making company cannot be excluded merely because it reported a loss if it is otherwise functionally similar to the tested party. It also noted that the same entity had been accepted by the Revenue in earlier and subsequent years, supporting its comparability. On that basis, ICRA Management Consulting Services Ltd. was wrongly excluded from the comparable set, and the assessee's margin would have fallen within the permissible range if it were included. The transfer pricing adjustment was therefore unsustainable and was deleted in favour of the assessee.

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Issues: Whether, in determining the arm's length price of the international transactions, a company that was functionally comparable but had reported a loss could be excluded from the set of comparables, and whether the consequent transfer pricing adjustment was sustainable.

Analysis: The assessee had selected comparables and used multiple-year data, but the transfer pricing adjustment ultimately turned on the exclusion of ICRA Management Consulting Services Ltd. from the comparable set on the ground that it had suffered a loss during the relevant year. The Tribunal held that the decisive test for comparability is functional similarity, not the commercial result in a particular year. It found that profit and loss are only outcomes of business activity and that a loss-making comparable cannot be excluded merely for that reason if it is otherwise functionally similar. The Tribunal also noted that the same entity had been used by the Revenue in earlier and subsequent years, which reinforced its functional comparability. If that company was included, the assessee's margin would fall within the permissible range.

Conclusion: The exclusion of ICRA as a comparable was unjustified, the transfer pricing adjustment of Rs. 63.68 lakhs could not survive, and the issue was decided in favour of the assessee.

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