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Issues: (i) whether comparables with turnover exceeding Rs. 200 crores were liable to be excluded by applying an upper turnover filter, (ii) whether Rheal Software Pvt. Ltd. was to be included as a comparable despite the persistent loss filter, and (iii) whether Daffodil Software Pvt. Ltd. was functionally comparable to the assessee.
Issue (i): whether comparables with turnover exceeding Rs. 200 crores were liable to be excluded by applying an upper turnover filter.
Analysis: The assessee had a turnover of Rs. 106 crores in the software development segment and the comparables selected by the transfer pricing authorities included companies with turnover far above Rs. 200 crores. The turnover filter was applied on the lower side, and the same commercial logic required application of an upper turnover ceiling as well. In transfer pricing comparability under the TNMM, size, brand value, asset base, and market reach materially affect margins, and high-turnover companies cannot be compared with small-size service providers. The authorities accepted that companies above Rs. 200 crores fell outside the relevant size band.
Conclusion: The five companies with turnover exceeding Rs. 200 crores were directed to be excluded from the comparable set, in favour of the assessee.
Issue (ii): whether Rheal Software Pvt. Ltd. was to be included as a comparable despite the persistent loss filter.
Analysis: The company was accepted as functionally comparable, and the sole reason for exclusion was persistent losses. The annual records showed that the company had profits in one of the relevant years, so it did not satisfy a persistent loss pattern of successive losses for the relevant period. A company cannot be rejected on a persistent loss basis when it has earned profit in one of the three years considered for the filter.
Conclusion: Rheal Software Pvt. Ltd. was directed to be included in the list of comparables, in favour of the assessee.
Issue (iii): whether Daffodil Software Pvt. Ltd. was functionally comparable to the assessee.
Analysis: The company derived revenue from sale of products as well as services, and the annual report did not provide proper segmental information separating product and service streams. In the absence of reliable segmental details, a company engaged in product sales could not be treated as functionally comparable to a captive software development service provider.
Conclusion: Daffodil Software Pvt. Ltd. was directed to be excluded from the comparable set, in favour of the assessee.
Final Conclusion: The transfer pricing comparability exercise was modified by excluding the high-turnover companies, including Rheal Software Pvt. Ltd., and excluding Daffodil Software Pvt. Ltd., resulting in partial relief to the assessee.
Ratio Decidendi: In software development transfer pricing under TNMM, comparability must account for turnover band, functional similarity, and reliable segmental data, and a company with product sales or disqualifying size or persistent-loss characteristics cannot be retained as a comparable where those features materially distort margin comparison.
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