TNMM benchmarking permits reasonable adjustment for distortive software depreciation and exclusion of high-turnover comparables.

Under TNMM benchmarking, a materially distortive item affecting the tested party's profit level indicator may be adjusted if the adjustment is reasonably accurate under Rule 10B, and depreciation linked to capitalised in-house software was treated as such a difference. The note states that the software depreciation materially affected the assessee's margin in the relevant year, so its exclusion from PLI computation was upheld and the margin was to be recomputed. It also explains that comparability must reflect functions, assets, risks and turnover, leading to exclusion of very high-turnover comparables. Functional dissimilarity objections were not finally resolved and were remitted for fresh factual examination.

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Issues: (i) Whether depreciation on the in-house software, claimed in the books, could be excluded while computing the assessee's PLI under TNMM for benchmarking the international transaction; (ii) Whether certain comparables were liable to be excluded on the ground of excessive turnover and whether the question of functional dissimilarity required fresh examination.

Issue (i): Whether depreciation on the in-house software, claimed in the books, could be excluded while computing the assessee's PLI under TNMM for benchmarking the international transaction.

Analysis: Under Rule 10B(1)(e) and Rule 10B(3), net profit margins under TNMM are to be compared after making reasonably accurate adjustments for differences that materially affect profitability. The assessee demonstrated that the major portion of its depreciation related to capitalised in-house CRM software, that this depreciation materially distorted its margin in the impugned year, and that the software's revenue impact became meaningful only in later years. The material difference between the assessee's margin and the comparables' depreciation profile justified a year-specific adjustment for benchmarking purposes.

Conclusion: The exclusion of depreciation on the in-house software for PLI computation was upheld, and the TPO was directed to recompute the PLI accordingly.

Issue (ii): Whether certain comparables were liable to be excluded on the ground of excessive turnover and whether the question of functional dissimilarity required fresh examination.

Analysis: Comparability under TNMM must be evaluated with reference to functions, assets and risks, and turnover materially affects comparability. Companies with turnover many times higher than the assessee's were found unsuitable, and the upper turnover filter was held applicable on the facts. As to the functional dissimilarity objections, the record showed that the assessee's functional profile in the transfer pricing study was broader than pure software development, while the objections had not been fully examined at the lower stages; therefore the matter required reconsideration on a proper factual basis.

Conclusion: The comparables with excessive turnover were directed to be excluded, and the functional dissimilarity objections were remitted to the TPO for fresh consideration.

Final Conclusion: The transfer pricing adjustment was not sustained in its existing form; the assessee succeeded on the depreciation adjustment and turnover-based exclusion of comparables, while the remaining comparability issue was sent back for fresh adjudication.

Ratio Decidendi: Under TNMM, a materially distortive item affecting the tested party's margin may be adjusted if the adjustment is reasonably accurate, and comparability must account for functional similarity and turnover-related differences that materially affect profit margins.

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