Transfer pricing comparability for software services excludes functionally different companies and requires working capital adjustment for reliable benchmarking.

In transfer pricing benchmarking of a captive software development service provider, companies with materially different functions, product revenues, brand-driven advantages, inadequate segmental data, or failure of the related party transactions filter were treated as unsuitable comparables. Sonata Software Ltd. was excluded for failing the related party transactions filter, while E Infochips Bangalore Ltd., Infinite Data Systems Pvt. Ltd. and Infosys Ltd. were excluded because their revenue mix, service profile, scale, brand value, or lack of reliable segmental data made comparison unreliable. Working capital differences were also required to be adjusted to ensure proper arm's length benchmarking, resulting in partial relief to the assessee.

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Issues: (i) whether Sonata Software Ltd., E Infochips Bangalore Ltd., Infinite Data Systems Pvt. Ltd. and Infosys Ltd. were liable to be excluded from the final set of comparables for benchmarking the assessee's software development services; (ii) whether working capital adjustment was required to be granted in computing the arm's length price.

Issue (i): whether Sonata Software Ltd., E Infochips Bangalore Ltd., Infinite Data Systems Pvt. Ltd. and Infosys Ltd. were liable to be excluded from the final set of comparables for benchmarking the assessee's software development services.

Analysis: The comparability analysis was tested on functional similarity, related party transactions, availability of segmental data, and whether a company with product revenues, brand advantages, or materially different business profile could be used as a comparable to a captive software development service provider. Sonata Software Ltd. failed the related party transactions filter. E Infochips Bangalore Ltd. derived revenues from multiple streams and lacked reliable segmental information for software development services. Infinite Data Systems Pvt. Ltd. rendered a wider and materially different set of technical consultancy and software-related services, with no segmental break-up to isolate comparable activity. Infosys Ltd. was a giant company with software product revenues, significant brand value, and a materially different scale and functional profile, with no segmental data enabling a proper comparison.

Conclusion: All four companies were directed to be excluded from the final set of comparables, in favour of the assessee.

Issue (ii): whether working capital adjustment was required to be granted in computing the arm's length price.

Analysis: Working capital differences affect comparability of margins in transfer pricing analysis, and the directions of the Dispute Resolution Panel required such adjustment to be given. Once the final comparable set was narrowed by exclusion of the non-comparable companies, the adjustment became necessary for proper benchmarking.

Conclusion: Working capital adjustment was directed to be allowed in favour of the assessee.

Final Conclusion: The transfer pricing adjustment was substantially reduced by excluding the non-comparable companies and by granting working capital adjustment, and the appeal was disposed of with partial relief to the assessee.

Ratio Decidendi: In transfer pricing benchmarking of a captive software development service provider, companies with materially different functions, product revenues, brand-driven advantages, insufficient segmental data, or failure of the applied related party transactions filter cannot be treated as comparables, and working capital differences must be adjusted to achieve reliable comparability.

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