Functional comparability in transfer pricing led to exclusion of unsuitable comparables and recomputation of arm's length price.

Functional comparability governs transfer pricing under TNMM: companies engaged in software products, KPO, engineering and consulting, diversified activities, or lacking reliable segmental data were held unsuitable for comparison with a routine software development service provider, and the ALP was to be recomputed after excluding those comparables. In the marketing support services segment, ICC International Agencies Ltd. was excluded because it earned trading income and held inventories, making it functionally dissimilar to a service provider; working capital adjustment was also directed to be examined and granted after hearing the assessee. Transfer pricing additions were thus not sustained in full.

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Issues: (i) Whether the comparables selected by the transfer pricing authorities for the software development services segment were liable to be excluded and the arm's length price recomputed accordingly; (ii) Whether ICC International Agencies Ltd. was a valid comparable in the marketing support services segment and whether working capital adjustment was to be allowed.

Issue (i): Whether the comparables selected by the transfer pricing authorities for the software development services segment were liable to be excluded and the arm's length price recomputed accordingly

Analysis: The software development services segment was examined under the transactional net margin method with operating profit to operating cost as the profit level indicator. The challenged comparables were tested on functional similarity and earlier Tribunal rulings relating to companies engaged in software products, knowledge process outsourcing, engineering and consulting services, diversified activities, absence of segmental information, onsite revenue profile, and related party transaction levels. Applying the earlier coordinate bench decisions, the impugned comparables were found not suitable for comparison with a routine software development service provider.

Conclusion: The exclusion of the challenged comparables in the software development services segment was upheld and the transfer pricing adjustment was to be recomputed in the assessee's favour on that segment.

Issue (ii): Whether ICC International Agencies Ltd. was a valid comparable in the marketing support services segment and whether working capital adjustment was to be allowed

Analysis: For the marketing support services segment, ICC International Agencies Ltd. was examined on functional comparability and was found to derive income from trading activity while maintaining inventories, making it dissimilar to a service provider. The Tribunal also directed that working capital adjustment be examined and granted after considering the assessee's claim and after affording an opportunity of hearing.

Conclusion: ICC International Agencies Ltd. was excluded from the comparable set and working capital adjustment was directed to be considered in favour of the assessee.

Final Conclusion: The transfer pricing additions were not sustained in full and the matter was allowed to the extent of recomputation of the arm's length price by excluding the disapproved comparables and by considering working capital adjustment.

Ratio Decidendi: A company is not a valid transfer pricing comparable where functional dissimilarity, absence of reliable segmental data, product or trading activity, or materially different risk profile makes comparison with a service provider unreliable; comparables must be selected on functional similarity and reliable profitability data.

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