Transfer-pricing comparability requires scale and functional alignment, excluding high-turnover and diversified technology companies from captive software-service benchmarking.
Transfer-pricing benchmarking requires comparable companies to be functionally similar and reasonably comparable in scale. When implementing a DRP direction to recompute margins from annual reports, the TPO must remain within that direction and cannot exclude expenses as non-operating without a corresponding direction; margins require recomputation without those exclusions. High-turnover companies may be excluded where turnover disparity makes them unsuitable comparables for captive software-development services. Companies providing diversified, high-end technology, product-development, artificial intelligence, cloud, blockchain and specialised services are not functionally comparable with routine captive software-development and testing services. The arm's-length price requires redetermination after applying these comparability filters.
Issues: (i) Whether the TPO could, while giving effect to the DRP's direction to recompute margins from annual reports, exclude expenses as non-operating
(ii) Whether two comparables whose turnover exceeded Rs. 200 crore could remain comparables for the assessee's software-development services
(iii) Whether five selected comparables performing diversified, high-end technology and product-related functions were functionally comparable to the assessee's captive software development and testing services
Issue (i): Whether the TPO could, while giving effect to the DRP's direction to recompute margins from annual reports, exclude expenses as non-operating
Analysis: The DRP's direction required recomputation of comparable margins using their annual reports. The exclusion of certain expenses as non-operating, without a corresponding direction, exceeded that limited mandate and resulted in enhanced operating margins and transfer-pricing adjustment.
Conclusion: Comparable margins must be recomputed from the annual reports without the impugned expense exclusions, in favour of the assessee.
Issue (ii): Whether two comparables whose turnover exceeded Rs. 200 crore could remain comparables for the assessee's software-development services
Analysis: The assessee's turnover was Rs. 32.24 crore, whereas the two comparables had turnover of Rs. 1,142 crore and Rs. 392 crore respectively, with similarly substantial disparity in earlier years. The turnover filter was material to comparability, and companies having turnover above Rs. 200 crore were not scale-comparable.
Conclusion: The two high-turnover comparables must be excluded, in favour of the assessee.
Issue (iii): Whether five selected comparables performing diversified, high-end technology and product-related functions were functionally comparable to the assessee's captive software development and testing services
Analysis: The assessee provided captive development and testing services for medical-imaging software. The selected comparables undertook diversified high-end functions, including digital and cloud engineering, artificial intelligence, machine learning, data engineering, blockchain, product development, and specialised technology services. Such activities were materially different from the assessee's routine software-development functions, defeating functional comparability.
Conclusion: The five functionally dissimilar comparables must be excluded, in favour of the assessee.
Final Conclusion: The arm's-length-price determination must be redetermined after recomputing margins in accordance with the DRP's direction and excluding the identified non-comparable companies.
Ratio Decidendi: Transfer-pricing benchmarking requires comparables that are functionally similar and reasonably comparable in scale, and the TPO cannot exceed the scope of the DRP's directions while giving effect to them.